How to Say No to Outsourcing

The boss may assume that outsourcing is the answer to everything. But CIOs can't afford to assume anything. They have to know.

It’s a scenario scary enough to induce night sweats in even the steeliest CIO. Your CEO, just back from a conference in Phoenix, strides into your office. Yesterday, he played golf with the vice president of sales for one of the big IT services companies and now he’s telling you that this company could take over most of your IT functions and cut your company’s IT budget in half. Not only that, they can deliver better services levels. After all, it’s what they do!

Our business isn’t IT anyway, the CEO continues, waxing enthusiastic. And our biggest competitor just signed an outsourcing megadeal, too. Best of all, there’s no need for a long, drawn-out RFP process. "Just call this guy up tomorrow," the boss says with a big smile, sliding a blue-and-white business card across your desk. He’s doing you a favor. "It’s practically a done deal," he concludes happily.

For many CIOs, this nightmare is neither a dream nor all that uncommon. But unlike most dreams, the morning after brings consequences that are all too real. Outsourcing a particular function within IT—or all of them—without considerable study can have disastrous consequences that you, not your CEO, will have to solve.

In the past year alone, 47 percent of companies have prematurely ended an outsourcing arrangement, according to research by Diamond Management and Technology Consultants. Forty-three percent of them brought the work back in-house, indicating it may not have been a good decision to farm out the function in the first place.

"Outsourcing, onshore or offshore, if not done right or done for the right reasons, can tip things the wrong way," says Chris Jones, principal of consultancy Source:Renaissance. "It can have negative effects on IT, on the business and, ultimately, your customers."

How to Get Ready for the CEO

Short of locking the executive team in a tower, there’s no way to prevent them from falling under the influence of high-pressure, enthusiastic vendors. Selling is what vendors do. But you can ensure you’re not backed into a corner on a decision as important as outsourcing a portion of IT’s portfolio. How? By having a well-thought-out and clearly articulated IT sourcing strategy already in place when your CEO comes knocking.

"The most mature IT organizations understand the whole of their operations. They have good metrics to track costs and service levels. They know the different points in the enterprise that could affect the IT operation as a whole," says Dane Anderson, research director of IT services and sourcing for Gartner. "They have a sourcing strategy already pulled together to defend against misleading or poorly thought-through outsourcing decisions long before the big ’O’ word even comes down from on high."

The point of such a plan is not to build an a priori case against outsourcing. The goal is to gather all the facts—such as how IT fits into the overall business strategy, what the real costs and service levels are internally, how they compare with the outsourcing market, as well as input from relevant business constituents—to create a fair-minded framework for making the best sourcing decision in any situation. "It’s much better to proactively investigate the sourcing alternatives," says Jeffrey M. Kaplan, managing director of consultancy ThinkStrategies, "than to find yourself reacting to proposals from your superiors."

Doing all this takes time and effort. But with such a politically charged decision as outsourcing, such a plan goes a long way toward keeping emotion out of the debate. "I recommend that every CIO build an internal core competency in sourcing decision making. This way, when the CEO or CFO says, ’I just spoke to EDS or BearingPoint and they can do all this for me—why shouldn’t we let them do it?’ you can say, ’Great question! Here’s why,’" says Thomas Koulopoulos, executive director of Perot Systems Innovation Labs and author of Smartsourcing.

"And if the question hasn’t been asked yet," Koulopoulos says, "be assured it will be."

Tie Sourcing Strategy to Business Strategy

Business executives have their own motivations when it comes to outsourcing IT functions. A CEO may see it as a chance to focus internal employees on core competencies or to transfer risk to a vendor. A CFO will be scouting for an opportunity to slice 30 percent off the bottom line.

CIOs can have good reasons not to outsource a certain function at a particular point in time. The trouble is that the CIOs’ first line of defense tends to be IT-centric, which sounds self-serving. As a result, says Phil Hatch, founder of sourcing consultancy Ventoro, "they’re not getting enough traction [with executives] when they explain what might be dangerous about outsourcing a certain problem."

The solution is to create a sourcing strategy that’s tied to the overall business strategy. Sixty-five percent of IT organizations lack a sourcing plan, says Anderson of Gartner. "And those that do have a document collecting dust. It’s like the letter to shareholders in the annual report. It’s not an actionable document. It doesn’t tell you how these decisions will be made."

A good sourcing strategy starts with the goals of the corporation and works from that to lay out the objectives for IT. That clear connection will enable the CIO to create a decision framework to guide sourcing choices.

How Dow Does It

Dow Chemical’s IT leadership hasn’t been bashful about outsourcing—or about how IT sourcing decisions fit into the big picture. "At Dow, our overall vision is to be the largest, most respected chemical company in the world," says Mack Murrell, the senior director of information systems and office facilities for the $46.3 billion chemical company. "That says a lot."

What says more are the principles the company follows to achieve that goal. "Everything in IT aligns to one or more of our four strategic themes: driving financial discipline, creating sustainability, focusing on people and investing for growth," says Murrell. Keeping those principles in mind makes sourcing decisions easier—and easier to sell to the business. Dow outsources between 60 percent and 85 percent of IT functions, depending on the workload and business cycle. (Most IT investments occur during profitable peaks in Dow’s cyclical business.)

Dow IT’s sourcing decisions start with an assessment of skills available internally and externally. Then IT can hand an activity to an outsourcer, augment its own staff or do a combination of the two, depending on the task’s strategic importance. However, core activities such as architecture, major technology decisions, contract management, security and senior-level relationships with the business that tie into Dow’s four strategic themes stay in-house.

The desire to drive financial discipline led Dow to sign a 10-year deal with Hewlett-Packard to handle its global help desk. "We don’t have to spend the money to build those skills up globally," Murrell says. "[HP has] much more scale and they can worry about where the talent pools are and how to make the financials work."

At the same time, Dow has kept its mainframe operations in-house, even though that’s an area a lot of companies outsource without a second thought. "We looked at it because so many people were outsourcing it," says Murrell. "But we have not been able to find a company that can approach what we spend today." Again, the theme is financial discipline. Dow’s internal IT resources can do the job for about 20 percent less than the leading third-party providers and the key is that Murrell knows this, has researched this and has those numbers at his fingertips.

Dow’s focus on growth led to Murrell’s decision to insource the bulk of the application development work he once sent to Shanghai. The Chinese market is an important growth opportunity for Dow. Outsourcer Accenture is involved in Dow’s Shanghai development shop, but the majority of employees work for Dow. "It was an opportunity to hire people, get to know China and be ready for doing more business there. Meanwhile, they are learning Dow work processes as they work on IT projects," says Murrell. "Our partnership with Accenture has been very helpful in that process, but we identified and are driving that opportunity, not the other way around."

"What Dow has done is not unique," says Jeanne Ross, principal research scientist at MIT’s Center for Information Systems Research. "But it’s clearly articulated." It doesn’t guarantee success, of course. In 2004, Dow ended a seven-year networking deal with EDS three years early (Dow transferred that work to IBM because it thought IBM "could provide more long-term value").

Problems may occur in the course of any outsourcing relationship but a sourcing strategy ensures that initial decisions are made in the context of where the business is headed. "It provides a common language that’s understood across the company," says Murrell. At Dow, the four driving principles are beat like a drum from the CEO on down. But that’s not true in all organizations. At those companies, the CIO must engage the business in conversations about the company’s core mission and how IT can best help achieve it. "If you don’t, you’re at huge risk and so is the IT group," says Koulopoulos of Perot Systems. "Someone will come around and say, ’Why don’t we outsource everything in IT?’"

How to Calculate the True Costs of Sourcing Options

Creating a business-driven sourcing strategy is an important first step. But an apples-to-apples comparison of what it costs to insource a function versus outsourcing it must be fed into that framework. Outsourcers will always claim they can do better in terms of costs and service levels than internal IT—it’s what they do—so building a case against outsourcing may hinge on fact-checking that claim. "You have to be able to say, ’Here are our actual costs and service levels. Here’s what the provider can offer. Let’s figure out what makes a good case,’" says Gartner’s Anderson.

Many IT organizations lack a true understanding of their internal costs and service levels. "For years, the business put money into IT because that was the cost of doing business. But now they’re asking some hard questions," says Koulopoulos. "Unfortunately, the costs are often buried and there are no benchmarks."

Guesstimates won’t do. To make a case for or against outsourcing an IT function, CIOs must know at a granular level how much their company spends on it internally. "You have to do it based on actual IT expenditures, not budget performance. Even labor costs at the macro level aren’t good enough because one developer may be doing work in several different areas," says Harry Wallaesa, founder of IT consultancy The W Group.

Better, Faster and Cheaper at Vanguard

Jeff Dowds, IT principal, systems integration, who is in charge of delivering IT services for three of Vanguard’s four lines of business, was always clear about the fact that the company’s business strategy drives his IT sourcing decisions. But if you’d asked him two years ago about the service levels, costs and productivity of the mostly insourced IT department, he couldn’t have told you. It was a tricky place to be for an IT executive overseeing an internal development staff of 1,600, even as competitors were doing more and more outsourcing.

It’s easy to see why IT went the do-it-yourself route at Vanguard. The mutual fund company operates virtually, and technology is the link between the business and the customers. "We wouldn’t outsource all of our technology any more than we’d outsource our money management," Dowds says.

But one of Vanguard’s strategic objectives is to keep costs low. If IT couldn’t prove it was doing better than an outside provider, the decision to eschew outsourcing could come into question. "Delivering custom-built technology in-house is expensive and we pay a premium doing that work in-house and onshore. But we’re always interested in being better, faster, cheaper," says Dowds.

In 2004, Dowds started to laser in on costs and quality metrics. He knew he was probably paying a premium to keep development in-house and needed to validate that investment with returns like developer productivity and software quality. But "it was a struggle to figure out how to best measure it and get the accounting right," says Dowds. "We have to do it a consistent way to justify our choice to keep development in-house."

As for costs, he says, "we don’t cost account ourselves to death," he says. For each project, Dowds multiplies the hourly cost for developers times the number of developer-hours required and tacks on an additional 15 percent for infrastructure costs (say, additional Unix processing horsepower or increased storage) and another 15 percent for the businesspeople who work with IT on the project. "I don’t want to say it’s precise," says Dowds, "but it works well."

The data has enabled IT to justify its sourcing decisions to the business and stave off pressure to offshore application development. "IT is the biggest cost to the business and we don’t get a free pass," says Dowds. "We have a Vanguard governance group at the most senior level and they will challenge IT on how it sources development. We have been able to show them what our costs and productivity are and how we can manage them better. Outsourcing is not the only way to drive IT costs down. We can be more efficient and more productive."

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