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Outsourcing Services Function

Chapter 3 Literature Review

Introduction

This chapter highlights the literature review of the project definitions of outsourcing. It also identifies the reasons to choose reported by different authors. Furthermore, this chapter discuss the risks and benefits of IT outsourcing. The chapter is divided into four main sections i.e. definition of outsourcing, reasons. The chapter consists of different of outsourcing, risks and benefits of IT outsourcing, and outsourcing management.

Outsourcing Origin and Definition

Grover and Teng (1993) have argued that contracting computer related services is not a new concept but a practice which was common during the 1960s and 1970s in small and medium sized organizations that sought capabilities and specialties which they were unable to produce internally. An opposing view is that presented by Tayntor (2001) who suggested that the term outsourcing appeared later than the '70s i.e. in the 1990s emerging from the morbid economy of the 1980s and early 1990s with the primary focus to cut costs.

Livingstone (1992) presented a view which would argue that outsourcing implies two perspectives. Firstly, the narrower and traditional outsourcing sense in which a firm hires a third party to perform the operations and does not maintain ownership. It delegates the entire process to an outside vendor or to contract with another organization to provide services or products of a major function or activity. Examples of traditional outsourcing include call centers, network management, or application support outsourcing. The second implication of outsourcing is to contract tasks and processes outside the boundaries of the firm in the form of acquisitions, green-field subsidiaries and joint ventures (Livingstone, 1992).

Various definitions of outsourcing have been proposed by several management researchers as follows:

Gilley and Rasheed (2000) have defined outsourcing as "procuring something that was either originally sourced internally (vertical disintegration) or could have been sourced internally notwithstanding the decision to go outside (make or buy)."

Brooks (2004) defines outsourcing as "procuring of services or products from outside suppliers or manufacturers."

Fan (2000) defines outsourcing as "a contractual agreement between a principal organization and number of specialized suppliers of different services or processes which were carried and provided by the organization internally."

In supply chain, management outsourcing explains the transforming responsibility process for a particular business procedure from in-house to another organization. In any successful supply chain function the most important decision is whether and how to outsource (Chopra & Meindl 2007). McIvor (2000) emphasizes that the modern world has seen the challenges of not only mundane operations being outsourced but the immense growing trend of professional services as well. It has now transformed from the peripheral concern of cleaning, catering and security to critical activities of design, manufacturing, marketing, distribution and information systems with the inclusion of the entire supply chain of an organization to the outside supplier.

Of the above, I prefer to follow the definition that describes outsourcing in the terms proposed by Fan (2000). With regards to this study, emphasis and focus will be placed on this understanding.

Information Technology (IT) Outsourcing

"IT (information technology) is a term that encompasses all forms of technology used to create, store, exchange, and use information in its various forms (business data, voice conversations, still images, motion pictures, multimedia presentations, and other forms, including those not yet conceived). It is a convenient term for including both telephony and computer technology in the same word." Carmel and Tajia (2005, pp insert page number for quote)

Globalization, competition, headcount problem, flat structured organizations, more flexibility, dynamically changing technology and an urge to focus on core competencies are argued as major factors for Information technology outsourcing (Atkinson, 1985). When a product or service starts loosing its value and gaining a status of a commodity, than organizations increase their focus on core activities and rely on external suppliers for a commodity status product or service (Venkatraman, 1997). In this regard IT is becoming more of a commodity for most organizations as they start outsourcing and relying on external suppliers for internal IT based functions and processes.

As a frequently updated domain, IT has grown phenomenally in the last decade in North America, the UK, Western Europe, South America and Australia (Grover et al., 1996), not surprising given the diverse usage and accessibility. Globally IT outsourcing involves the development and maintenance of applications by one or more service providers internationally.

The major areas for outsourcing include payroll systems, claims and credit card processing while on the other hand the developing segments of IT outsourcing include data centers, client/servers and help desk applications.

Types of IT Outsourcing

Urquhart (2002) argues for four different types of outsourcing as summarized below;

Urquhart (2002) describes total outsourcing as a core partnership with a single supplier, where IT is generally recognized as a service or support function. In total outsourcing the main concept is to reduce IT costs, or abolish a problem with IT functions, but the strategic control always remains in the hands of the outsourcing organization (Urquhart, 2002).

Where multiple suppliers are concerned, outsourcing organizations are not very keen in partnership due to the reduced opportunity to promote innovation and create more competition between suppliers. Contracts are generally short term, with the aim of less dependency on the suppliers and maintenance of strategic control (Urquhart, 2002).

Jointventures and strategic alliances are strategic partnerships aiming to develop something new for their customers; they further emphasize on shared risk and benefits. Normally some organizations promote the supplier company where they will outsource the work. However, organizations have more strategic control than they would exercise in a total outsourcing or multiple suppliers outsourcing (Currie and Willcocks, 1997).

In-sourcing involves maintaining the IT or any other operational function in-house, considering it as a core function to their business. Normally in-sourcing takes place when organizations do not have the trust in the supplier that is necessary (Urquhart, 2002).

Zijlstra (2004) also reported four different forms of outsourcing which are essentially similar to those proposed by Urquhart (2002). Zijlstra (2004) has provided different titles to what he believes are the four main types of outsourcing.

Firstly, Zijlstra (2004) identified Business Process Outsourcing (BPO) not only as an additional expression for outsourcing, but also as a means of adding strategic value by resourcefully investigating the procedures that motivate the business functions. BPO has developed as an industry in recent years with best practices. BPO services are now efficient, vigorous and protected in many areas, such as Customer Relationship Management (CRM) outsourcing, finance & accounting, human resources, supply chain management, financial process management, procurement and payment and billing.

Offshore outsourcing described by Zijlstra (2004) has been re-defined by Sparrow (2005) as the transfer of responsibility related to any IT service, specifically application development, by an external service provider residing in any other country. Off shoring is a part of orthodox business strategies, offshore outsourcing initiatives are being accorded as significant by senior leadership oversight, and there is increasing emphasis on leveraging the model for greater strategic business impact; not restricted to functional support (Business insight BPO outsourcing, 2007).

Thirdly, out tasking, which is in fact no different than employing external knowledge to carry out one-off task, is more striking for smaller companies where it is not feasible to retain certain expertise themselves. Pivotal in this case is that the supplier builds sufficient knowledge about the customer and its exact situation to facilitate them to deliver added value and be responsible for the implementation of these tasks (Zijlstra, 2004).

The fourth type of outsourcing described by Zijlstra (2004) is application service provider which refers to a situation where a company is required to pay for the use of an application that is offered by a third party over a certain time. In this case the supplier is responsible to buy, manage and maintain the applications and the customer is viewed as a user, for example statistical database (Zijlstra, 2004).

Edgell et al. (2008) discuss that major areas of outsourcing these days are Information Technology (data centers, call centers, CRM, ERPs and ASPs), human resource (recruitment and selection), marketing (survey, research and advertising), and finance (payroll, insurance and auditing)

3.5. Reasons for IT Outsourcing

Information technology is one of the most dynamic, diverse and changing fields in the business world (add reference). Most organizations try to keep themselves aligned with the changing scenario in the field. Hi-pace acquisition and a breath taking rate of maintenance of technology gave birth to outsourcing. In view of Grover et al (1996) outsourcing becomes an important and strategic alternative to acquire and manage, complex and costly information technology. Shortage in the IT labour market, expanding technological infrastructure, increasing popularity of Enterprise Resource Planning (ERP), e-commerce technologies and limited internal resources are also pressurizing for organizations leading them to outsource the IT department and let it be handled by specialized and professional service providers (Soliman and Chen 2002). In case of application outsourcing, Application Service Providers (ASP) is a new emerging concept in the sector as a popular method. ASP vendors develop, deploy and manage application and service from remote data centers for multiple users through the internet (Currie and Willcocks 1997). As proposed by Worthington (1997) there are six reasons for outsourcing like access to technology, focus on core business, cost savings, flexibility, accountability, and access to skill. However, in the opinion of Kakabadse and Kakabadse (2000a) there are three major reasons for IT outsourcing cost, strategy and politics. Where, politics is specifically related to public sector outsourcing. They justify that all other categories are sub categories of these three major factors; details of each are summarized in the table 3.1 below.

Table 3.1: Reasons for IT outsourcing

There are many reasons to be considered when deciding whether or not to outsource. Lacity and Willcocks (1997) have reported 15 such reasons to choose IT outsourcing. They conducted a research in the UK market with a sample size of 61. Table 3.2 below shows the reasons in order of hierarchy (1 being at the top).

Table 3.2: Reasons/Expectations to choose outsourcing (Lacity & Willcocks, 1997)

Benefits of IT Outsourcing

Referring back to the above mention of reasons to outsource, Lacity and Willcocks (2001) suggest that in the case of IT outsourcing, different organizations expect different types of beneficial output. Circumstances range between different organizations which inevitably result in different types of benefits. Some organizations want to focus on their core competencies, some want to cut costs while want to keep themselves up-to-date with new technology (Harler, 2000).

It is near to impossible to list all possible benefit, however, some general benefits include a potentially improved service at a lower cost, increased flexibility and quality, access to latest technology and the ability to focus or re-focus scarce resources with core functions in mind (Kremic, 2006).

As well as the proposals made by Lacity & Willcocks (2001), benefits of outsourcing have also been suggested by Kliem and Quinn (1999). Such benefits include leveraging existing staff to focus on core activities on organizational specialization helping them in focusing on achieving main strategic objective, for instance. Further, they proposed lowering infrastructure and installation costs, gaining monetary advantage over competitors, providing adaptability to response to dynamic market conditions and minimizing investment in information technology.

Strategically outsourcing can benefit companies by allowing greater flexibility especially in acquiring dynamically changing technology or the countless components of complex systems (Carlson et al 1989; Harrison, 1994). Small scale specialized suppliers usually offer good responsiveness through new technology which have undermined the requirements of vertically linked organizations and have also helped in achieving economies scale (Quinn and Hilmer, 1994). With reference to the work of Carlson et al (1989), outsourcing can be viewed as providing a greater flexibility than the vertically integrated organization in the same way as a good network of suppliers provides any organization with the ability to adjust the scale and scope of their production capability upward and downward. On the other hand outsourcing can decrease product design cycle time; if the client uses multiple suppliers who simultaneously work on separate components of a system then each supplier can contribute more effectively on availability, design and the technological aspect of system. This will ultimately result in offering a better quality to client (Quinn and Hilmer, 1994).

In light of the arguments considered so far, as well as the contributions made by Currie & Wilcocks (1997), the most important advantage of outsourcing is full utilization of external suppliers' innovation, investment and professional capabilities so that it would be difficult to replicate by other competitors. Moreover, transforming fixed cost to variable cost by selling assets to an outsource vendor is considered advantageous for many organizations (Currie and Willcocks, 1997)

Risks of IT Outsourcing

There is an array of risks associated with outsourcing which are numerous. Firstly, outsourcing is considered as a new tool for managers, the complete cost of which is still unknown. Some scholars are of a opinion that suppliers usually overstate the benefits and are likely to serve better initially at the beginning of contract to make good first impression (Schwyn, 1999). Bounfour and Lonsdale (1999) identified a lack of development and methodology in this area as a cause control failure to some degree. Lonsdale (1999) suggested that mostly outsourcing projects fail due to the lack of methodology and guideline definitions as compared to inherent problems related with outsourcing. Table 3.3 below summarizes why IT outsourcing fails.

Table 3.3: Reasons for IT outsourcing failure

As defined by existing literature, the major risks linked with IT outsourcing are unrealized savings and future potential cost increase, human resource problems, increase dependence on suppliers, loss of corporate knowledge and future opportunities and unsatisfied customers. Poor contracts scope, incomplete requirement definition, lack of guidance in management and planning of outsourcing project and poor relation with supplier may also result in failure of outsourcing project. Moreover, Currie and Willcocks (1997) point out disadvantages of adopting outsourcing as a dependency on suppliers for service. They further add that the disappointment in realizing the potential hidden cost savings through outsourcing as well as the loss of control over core functions can be considered cons. Furthermore, by employing external agencies could inadvertently lead to a decrease in the level of motivation and morale existing employees have thus leading to unhealthy management relationship.

Privacy and security is another important risk factor which hinders organizations to outsource their IT functions. It can result in massive damage to firm existence if proper steps are not taken and precautions not practiced. Previous situations are evident where staff of vendor companies have accessed the sensitive data and transferred it to the competitor (Tafti, 2005). Information imbalance, i.e. the access to information when different for two parties can also be counted as one reason for failure of outsourcing (Gietzmann and Larsen, 1997). Other research looking at IT buyers and supplier information asymmetry and the cost of development has concluded that the cost of internal development and IT outsourcing is similar. Thus, arguing against major cost related benefits (Whang, 1992). These findings can in part be supported by the conclusions of PACG (1996) that state that although cost reduction is an advantage most organisations believe when outsourcing, in most cases they don't evidence the cost reduction anticipated. Research shows that only 5% of companies gain 'high' cost benefits and 39% of organizations evidence only 'mediocre' reductions (PACG, 1996).

Outsourcing Management

Referring back to the possible advantage of cost reduction, poorly managed outsourcing can lead to the cost of solving difficulties and getting an outsourced project back on track can deplete virtually all anticipated benefits, even if the monetary benefit is good (Soliman and Chen, 2002). In an attempt to maintain safe decision making and to ensure the optimal possible for a company, many organizations today are experimenting with IT outsourcing for small, non critical functions so that they can develop their proficiencies and be well placed to be more competitive in the future but fully exploiting the global IT service market. As discussed by British Computer Society (BCS) there are nine steps for successful outsourcing project (Sparrow, 2005).

3.7.1 Develop Outsourcing Strategy

The decision to outsource any IT project or service should be made within the framework of an overall sourcing strategy to ensure delivery is as desired and expected (Fink and Shoeib, 2003). Numerous businesses in the UK are faced by an almost perplexing display of technologies, suppliers and business models. An efficient sourcing strategy recognizes the most profitable method to supply different IT services, taking account of corporate priorities and culture thus lessening the internal burden posed on management and employees (Sparrow, 2005).

3.7.2 Identify Project

Upon deciding that outsourcing is what the organization requires, businesses then need to determine the degree to which they will use outsourced resources. To obtain the best results, organizations must think about this in terms of formulating a specific delivery model that integrates all outsourced IT functions to create synergy (Sparrow, 2005).

3.7.3 Prepare Objectives

Zhu et al. (2001) argue that each project needs clear objectives to ensure smooth running. By making clear at the outset what the organization wants to attain and how it will know when it has reached its goals, companies can reduce the risks involved in IT outsourcing. Sparrow (2005) suggests that the objectives to determine include:

Organization structure and management of the outsourcing program

Opting for a suitable delivery model

Performance measurement

What type of relationship organization wants with service provider?

3.7.4 Develop Statement of Requirement

In order for an outsourced project to be successful, a clear statement and plan need to be developed and communicated between the relevant bodies. By aiming to create specific and complete written documents stating the exact objectives and work to be done, geographically distant, non native English speaking teams would better be able to comprehend the organization's requirements and maneuver themselves to achieve these. The two key documents in this regard are: the statement of requirement and service level agreement (Sparrow, 2005).

3.7.5 Investigate Market

Halvey and Melby (1996) suggested that vendor selection should be based on comprehensive research on part of the organizations, for example, by talking to their clients and visiting their sites. Organizations should evaluate the strengths and weaknesses of individual vendors and specifically examine the vendor that best meets the requirements by assessing or considering previous projects undertaken by vendors as well a looking at the sufficiency of resources they have available (Sparrow, 2005).

3.7.6 Choosing a Service Provider

Halvey and Melby, 1996; Minoli, 1995) have recommended that the organizations should focus on a vendor's track record, knowledge of industry, technical and industry experience and willingness to negotiate before contractual agreements are reached. The appropriacy of the vendor during the selection period would depend largely on the required outputs so the organization needs to define clearly and explicitly what it needs the service provider to perform (Minoli, 1995).

3.7.7 Negotiate Contract

An IT outsourcing contract should include potential risks and all key concerns associated with outsourcing as it plays an important role in protecting the interests and rights of an organization. The contract also defines the boundaries, nature, scope and all other expectations from the organization (Fink and Shoeib, 2003)

3.7.8 Transition phase

In working collectively to reach a shared goal, the organization should spare sufficient IT staff to educate and train the vendor team (if required) on services they use and provide to others and how and where the vendor fits in.Knowledge transfer is therefore an important element in any IT outsourcing transition plan. This stage is resource hungry in nature, the IT operations must continue as before even though the knowledge transfer process takes up a lot of time (Sparrow, 2005).

3.7.9 Managing performance and supplier relations

Managing the performance of a project which has been outsourced is a major challenge for most organizations as they need to develop and maintain a good level of trust with the supplier/vendor organization in order to ensure a consistent level of performance. Key performance indicators (KPIs) are one way of assessing ongoing improvement and therefore should be devised and transmitted clearly at the earliest possible stage so that vendors can bear them in mind when planning and executing the project (Sparrow, 2005).

A number of client-client based relationships exist which have been presented by Nam et al. (1996) who have identified four types: support, reliance, alignment, and alliance. Support refers to the most primitive form of any outsourcing arrangement and involves the outsourcing of a small amount of non-critical IT functions to the vendor initially. Reliance if formed, is when a long-term contractual agreement to provide the non-critical IT functions with the vendor is reached based on the work and relationship so far.

In cases clients are provided with consulting services on various strategic IT functions but the vendor may not necessarily be involved in IT operations. Such an arrangement is perceived to be alignment.The fourth type of outsourcing relationship described by Nam et al (1996) has been termed alliance. It requires the client to entrust its vendor with strategically critical IT functions completely and therefore involve them in more than strategic changes. Soliman and Chen (2002) suggest that when the organisation and vendor work closely and in harmony, the integration objectives of IT outsourcing will be better achieved in any type of structural setup.

Outsourcing Trends

"The IT outsourcing boom appears to be over, onshore providers are facing new pressures, and companies are outsourcing more strategically and selectively. While a majority of buyers — 64 percent (offshore) and 50 percent (onshore) — remain committed to increasing their purchasing, these numbers represent a significant decline from prior years."Insert page number

Summary

This chapter has demonstrated that outsourcing is a major function performed by many companies with numerous objectives in mind. There are various reasons to choose outsourcing as opposed to in-house development in any of its types. Reasons may vary by virtue of an organizations nature of business or industry sector. It has also been noticed that risks are more in number and strong in nature as compared with advantages. The chapter has also drawn attention towards the tough task of managing IT outsourcing.

In the following chapter the methodology of this research will be discussed.

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