The extended enterprise

For much of the last decade it was a tactic viewed with great suspicion by many IT professionals – a management ‘get out clause' favoured by business executives who doubted the strategic value of IT and who were mostly concerned about its escalating cost. Today, outsourcing is an accepted part of every CIO's play book, a business tool practised on an ever increasing scale by around 90% of Fortune 1,000 companies.

That mechanism is also multi-dimensional. At its very least, most IT organisations see outsourcing as a means of getting rid of the commodity side of IT – desktop management, data input, routine programming and testing and many data processing and specialist tasks. That, in theory, leaves the IT group to concentrate on truly business-enhancing projects. Alongside that, outsourcing is increasingly viewed as a means of divesting distinct IT-centric business functions – payroll and some other apsects of HR, call centre operations, claims processing (in insurance and healthcare) and other discrete functions. Some, such as National Savings & Investment (see box), have taken outsourcing to its limits in order to transform their complete operations.

That puts senior IT management in a new role, orchestrating a matrix of service contracts that might include internal IT operations, on-site third-party services, locally and globally sourced services and outsourced IT-enabled business processes.


In practice: National Savings & Investment

Six years ago, after almost 140 years as one of the government's most cost-effective sources of public borrowing, the UK's National Savings & Investment (NS&I) was starting to show its age.

"We were a fairly traditional government agency," remembers Steve Owen, NS&I's partnerships and operations director. "We were pretty competent, pretty good at what we did, but we were not market focused. We had high operational costs and we had started to shrink – we were losing market share."

Indeed, faced with growing competition from a deregulated, and rapidly modernising private financial services sector, the future of NS&I was in serious doubt. Its oldest product, the original Post Office Ordinary Saving account, was expensive to manage and its interest rate so uncompetitive that it was running at a loss. At the same time, the agency itself had ossified into three largely autonomous businesses that were each as inflexible as each other. Even Premium Bonds, NS&I's flagship product, was under threat from rivals like the National Lottery.

It was a huge problem, and it needed a dramatic solution. In April 1999, NS&I transferred 4,000 of its 4,200 staff to Siemens Business Systems, as part of 10-year public private partnership (PPP). While many observers at the time shook their heads and wrote off NS&I, that move has since become a blue ribbon example of how transformational outsourcing works.

By handing over day-to-day responsibility for administration of saving products to Siemens, Owen believes NS&I has been converted from an essentially passive "money taking" organisation, into an extremely flexible market driven business.

NS&I's executives are no longer worrying about how to consolidate the 13 separate IT systems, spread across three operational sites. These have been handed over to Siemens, and NS&I is able to "focus on the core business: on issues about the brand, product, design and pricing and not about details of operational services," says Owen.

The results have been dramatic. The past several years has seen NS&I at its most prolific, introducing a raft of new products and replacing the 140-year-old, passbook-based Ordinary Account with a card-based Easy Access Savings Account that is much cheaper to operate so it can offer savers four times the interest of its predecessor. It is an effort which has grown NS&I's once-shrinking deposits from £62.5 billion to £69 billion.

All of this has been achieved because, according to Owen "two organisations that are very good at what they do have benefited by working together." More specifically, they have benefited by sharing mutually beneficial goals.

Thus, although the first three years of its agreement with Siemens resembled a classic fixed-price outsourcing deal, since then "we have not cluttered up the relationship with service level agreements [SLAs]," explains Owen.

SLAs, of course, play an important roll in outsourcing, he acknowledges, but too much focus on them gets in the way of meeting larger goals such as, in the case of NS&I, revitalising a national institution that was waning in the face of modernity. The solution: outsource the past and concentrate on the future instead.



And that changing shape of IT delivery begs a key question: Has the IT profession entered a new era of strategic outsourcing?

Certainly, there is plenty of evidence to support the view that the management of outsourcing – whether of IT services or other business processes – is a strategic core competency, just as outsourcing has become a key skillset in other sectors.

So far, much of this global growth in outsourcing has been driven by industries and processes other than IT. Last year, according to business analysis group, Dun & Bradstreet, the global market for outsourced services of all types was already worth a staggering $4 trillion. In manufacturing, (where industry analysts are credited with coining "outsourcing" to describe a trend towards sub-contracting that swept the sector in the 1960s), outsourcing is now thought to account for 80% of all revenues in the business. For IT, the fun has just started.

Whereas in 2004 outsourced services accounted for around 25% of the average executive's budget, by the end of 2006, according to the International Association of Outsourcing Professionals (IAOP), this figure will have surged to 34%.

That translates into some big numbers. In 2002, according to analyst group Gartner, global spending on IT services reached $1.02 trillion, of which roughly 50% was accounted for by internally sourced services. Another 25% of the total was derived from what Gartner calls ‘discrete' IT services: those procured on a one-off, project-oriented basis that implies no long-term relationship with the supplier and no significant transfer of risk from the buyer to the supplier.

Just 25% of the 2002 IT services market revenue was accounted for by true outsourcing agreements where, by Gartner's definition, buyer and supplier enter into a long-term service relationship involving significant transfer of both risk and responsibility to the outsourcing partner. However, by 2007, when Gartner expects the global IT outsourcing market to reach $1.21 trillion, not only will externally sourced services comfortably account for more than 50% of this total but 33% of it will come from outsourced services.

Clearly, as far as market penetration is concerned, IT outsourcing has already passed what Gartner terms "the tipping point", after which IT service and resource delivery ceases to be primarily the responsibility of user organisations, and instead becomes the preserve of third-party providers. But has it been accepted as a strategic IT management practice, or is it still regarded as a quick-fix solution to IT cost and complexity?

Maturing patterns

In this respect, one aspect of IT outsourcing's recent evolution that its proponents are quick to emphasise is the escalating size, scope and timeframe of many modern IT outsourcing agreements. In the past several years in Europe, and in particular in the UK, outsourcing ‘mega-deals' have become headline news; in the first quarter of 2005 alone, 55 such deals were signed across Europe totally $11 billion in value, according to outsourcing market analyst TPI.

Contracts like these are testimony to the growing maturity of IT outsourcing practices and of the expanding expectations that outsourcing customers have in their suppliers, argues Michael Corbett, executive director of the IAOP. "At first outsourcing was all about costs: finding someone who could do the job better, cheaper, faster or all three" he says. Now though, outsourcing has become truly strategic: "The focus [is] growing to include the even larger opportunity costs savings that come when an organisation reinvests its freed resources back into higher value producing activities."

In IT outsourcing terms, Corbett is talking about contracts such as that between Amadeus and British Airways. By handing management of its booking systems and several other core data centre requirements to the Amadeus airline industry services house, BA was able to reallocate resources to new system development, accelerating the delivery of its applications and enabling it to defend the business against new competition from cut-price airlines.

However, successful as relationships like BA and Amadeus' may be, they are still not necessarily typical, nor are they necessarily the kind of example that most readily springs to mind when IT outsourcing is under consideration. Indeed, Michael Corbett's own research reveals that, far from regarding outsourcing as an opportunity to pursue larger strategic gains, in 48% of cases, business executives still cite cost reduction as their primary outsourcing motivator followed, in 17% of cases, by a desire to refocus on "core" business activities (see graph). Only 3% of business executives cited opportunities for increased innovation or quality as a reason for outsourcing.

This persistent view of IT outsourcing as primarily a cost reduction tactic is no obstacle to its adoption but it may often obstruct the success of outsourcing agreements.

Creating a successful, mutually beneficial and trusting relationship with an IT outsourcer is, after all, not so very different from recruiting a senior executive. Few senior recruitment initiatives are resolved by hiring the cheapest candidate; the fact that many outsourcing ‘recruitment' procedures are decided in precisely this way explain why, as recently as June 2004, research by IT analyst group Meta showed that 80% of outsourcing contracts did not meet customer expectations, and 60% encountered "business critical" problems.

Strategic thinking

So long as surveys such as Meta's keep appearing, it will be difficult for proponents to entirely win the argument in favour of outsourcing as a mature IT management strategy. However, this is not necessarily the fault of outsourcing per se, which like any business strategy, is only as effective as its execution by senior IT executives or, indeed, outsourcing services partners.

In one of the more telling pieces of outsourcing research published last year, PA Consulting polled its customers with experience of outsourcing, asking them if they agreed with the proposition "problems in outsourcing relationships are mainly the responsibility of the supplier." The response was far from predictable: 80% disagreed.

This does not mean that outsourcing customers are ready to exonerate their suppliers of all blame, but it does show that many organisations are beginning to face up to the fact that outsourcing is not a substitute for an IT strategy. In fact, IT outsourcing is an IT management strategy which demands as much, if not more, commitment and thought from business management as traditional in-house models.

Where that commitment and thought is absent is where outsourcing mostly commonly fails, says Duncan Aitchison, CEO of TPI, one of the world's largest sourcing advisory companies. "If you look where things go wrong, 30% of the time it is where the strategy was wrong in the first place, where there was no alignment with business goals. Bad strategy is bad strategy, and you can't manage it good," he says.

Fortunately Aitchison, whose company has acted in more than 700 outsourcing contract agreements with an aggregate value of more than $400 billion over the past 16 years, believes that attitudes really are starting to change. "Remember, the issue is bad management on both sides, not just the supplier side. We're seeing an appreciation of that now, and service quality has improved."

Ironically, one of the factors behind this maturing demand-side attitude and the accompanying improvement in the quality of the service delivered may be the growing role that offshoring is playing in outsourcing. The sourcing of IT services of all types primarily from India, but also now increasingly from China, Eastern Europe and South Africa, is one of the key drives of the larger outsourcing market. Undoubtedly, cost is the key motivation for companies to engage with offshore providers is cost. But, whereas cost-driven onshore outsourcing strategies are often highly problematic, observers like TPI's Aitchison note that this is rarely true of offshore contracts.

Perhaps because the perception of risk is higher when dealing with a distantly located services partner, and hence greater care is taken in contract negotiation and project and service management, offshore contracts appear to disappoint their customers only infrequently. In any case, confidence in offshore outsourcing providers is such that, according to TPI research, 81% of major UK companies with existing offshore agreements plan to increase their commitment to these services in the next two to three years.

Moreover, says Aitchison, UK offshore customers are increasingly coming to the conclusion that the services available from offshore providers are at least as good as, if not better than, those sourced closer to home. So, in stark contrast to the findings of surveys such as Meta's, TPI finds "very little disillusionment with offshore outsourcing. What we can observe is a shift towards more sophisticated sourcing strategies as the global market comes of age."

Not every IT organisation has developed that maturity and sophistication. But, just as outsourcing in textiles or electronics determined new sets of winners and losers in the 1980s and 1990s, the ability to successfully manage global IT service delivery will be a strategic differentiator for organisations in coming years.


Primary reason for outsourcing
Michael F Corbett and Associates

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Ben Rossi

Ben was Vitesse Media's editorial director, leading content creation and editorial strategy across all Vitesse products, including its market-leading B2B and consumer magazines, websites, research and...

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