IT Outsourcing: How Offshoring Can Kill Innovation

Harvard Business School professors David Pisano and Willy Shih argue that overzealous offshore outsourcing can cripple a company's ability to innovate. Pisano and Shih discuss what CIOs can learn from the manufacturing sector about how 'not' to approach offshore outsourcing.

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Page 2 of 2 Many CIOs have also embraced offshoring and are moving more complex and higher-value tasks abroad. What can they take away from your research?

Shih: It is a cautionary tale about the importance of understanding the long-term capability strategy in your company and understanding where the needs for capabilities in your company and your industry are going. The tricky thing is capabilities that seem unimportant today could turn out to be very important in the future because of the differing rates of improvement.

Pisano: Be aware. At the margin, it always seems to make sense to outsource the next highest source of value-added activity. But, over time, those capabilities erode, and you are at the mercy of those few suppliers with capabilities. Innovation is inextricably tied to IT in many industries today. Will the increasing offshoring of internal technology operations further erode American competitiveness?

Shih: A lot of IT outsourcing has resulted in the development of strong software capabilities in other parts of the world. It has accelerated the diffusion of this capability. The strong software commons in India and, increasingly, China bodes well for products for which software is an important component.

Pisano: Yes, no question about it. But, I don't want CIOs to come away with the message that we are against outsourcing—or that they should never outsource. That's not what we are saying at all. There is a lot of great IT capability in many different corners of the world, and it would be crazy for a CIO not to be thinking about how to take advantage of those. At the same time, they need to think about what they really need to have geographically close. It is clear that for IT professionals, the world is becoming a much more competitive place. If you are in that field, you are going to have to be continually improving your skill sets. And, if you are company in that space, you have to be innovating. You can't compete on cost. What advice would you offer CIOs and IT decision makers on striking the right balance between insourcing, outsourcing, and offshoring?

Shih: One global head of IT of a large airline company once told me, "You can't outsource your thinking." I think that captures one of the essences of what we're saying. It's important to understand where your capabilities come from, and how you sustain them. The focus in many companies—in terms of IT investment—continues to be cost savings. Can you give CIOs a financially based argument that they can take to their executive teams and boards against offshoring higher value capabilities?

Pisano: Sometimes there is no case against outsourcing. There are strong skills at very good costs available from lots of places. But, where they have to be careful is when they are outsourcing capabilities that become critical to the future. Can you justify that in some spreadsheet financial analysis? Probably. But standard tools of financial analysis are very limited when it comes to evaluating these kind of capability-creating decisions. You need management with judgment.

Shih: This is a classic short term versus long-term investment question. Long-term investments in capability maintenance and development are no different than other long-term investments in productive capacity. The harder thing to evaluate is the investment in the health of the commons. This is a classic "tragedy of the commons" problem; firms don't see the short-term benefits of such investments. That's one of the challenges. Our financial tools don't have a good way of capturing this.

Copyright © 2011 IDG Communications, Inc.

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