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In this report I will define outsourcing, examine which functions within a business can be outsourced and clarify in detail the advantages and disadvantages of outsourcing, whilst also investigating the alternatives and the future of outsourcing. An analysis of how a business may embark on a new outsourcing project and a review of IBM's outsourcing strategy is also made, finally India's role in information system outsourcing is analysed.
What is Outsourcing
Outsourcing is when a company contracts a department, function, or process of the business to an alternative company or relocates a specific department / division to a foreign country. This process has existed since the 1970's, however has seen a renaissance in recent years, and can facilitate a number of strategic advantages including being able to concentrate on the businesses core competences.
There are of course a number of different types of outsourcing; Business Process Outsourcing (BPO) is the outsourcing of back office operations to countries such as India which saves costs, an example of this is data entry, though these roles are unlikely to be directly related to information technology their orientation regularly requires IT department support. Legal process outsourcing (LPO) has become ever increasingly popular and is no longer restricted to low-end transcription work but includes a huge range of legal processes. Research Process Outsourcing (RPO) is the outsourcing of the research department, RPO confusingly is the Acronym for Recruitment Process Outsourcing which has become increasingly common and is the outsourcing of staff recruitment. RPO is a key component of Human Resource Outsourcing (HRO) which is the outsourcing of the human resource department to third party providers who provide a number of benefits due to knowledge of the domain.
It is important to review the different ways a business can outsource; Intra-group outsourcing is when a function is outsourced to a separate unit abroad within a large company (e.g. transferring the operation of the IT systems to an Indian subsidiary) this is considered internal restructuring and the service will remain captive within the company and will not be classed as a prominent transaction within merger control rules. When an outsource does not include any transfer of assets of employees or assets it is known as Simple outsourcing and is not classed as a notifiable transaction, this is in contrast to an outsource involving Transfer of assets when outsourcing includes the transfer of company resources / assets. The last option for outsourcing is a Joint venture between one or more business, this is achieved by all companies contributing resources into a new independent company or taking an equity stake and the objective is generally for organizations to benefit from the other's strengths.
What can be outsourced?
As almost all aspects of the day to day running of a business can be outsourced, I believe the question should be "what should be outsourced". There are a number of advantages of outsourcing which are discussed in the next section, with perhaps the most commonly known reason being cost cutting, but there are also a number of disadvantages which are also analysed in this report, it is necessary to assess these advantages, disadvantages and if the process be easily automated or standardized. I believe it is important to remember the fact that, even if the cost savings are dramatic it may cause the loss of long term competitive advantage and a business should normally only outsource a business function when, for whatever reason, it is not done well internally.
In the article "Linking Outsourcing to Business Strategy," authors Michael J. Werle and Richard C. Insinga, give an opinion that companies should keep control of activities that are true competitive differentiators or otherwise may have the potential to give a competitive advantage (an example of when a company has given competitive advantage due to outsourcing is explained later in this report). The article makes a distinction between "strategic" and "core" activities. Strategic activities are the main source to gain competitive advantage, while core activities are important to the company but do not offer a competitive advantage, the article continues and advises that businesses monitor the competitive environment as it changes constantly, and adjust accordingly.
The key drivers behind outsourcing;
There are a number of reasons outsourcing has become so popular, these advantages will enable a business to achieve a competitive advantage;
- Cost reduction - is the most common reason for outsourcing. Reductions in cost happen in a number of different ways, the most obvious way is the lowering of the overall cost due to overheads, many economies offer labor arbitrage which is generated by the wage gap between countries like India and the US (wages particularly in the information sector are much lower in countries such as India than the UK and US), an example of this is using a comparison between wages between India and the UK which is given later on in this report, additionally the average rent of commercial accommodation is dramatically lower in places like India compared with many western countries. Costs can also be reduced by outsourcing to the location of resources, these resources are not only employees (discussed in the next point) but also any raw material as this could save on shipping costs. Operating leverage (the measure of how revenue growth translates into growth in operating income) is improved due to changes in the ratio of fixed costs to variable costs and also ensures variable costs are easier to predict. The other cost advantage is that a number of countries offer tax incentives to companies wishing to outsource functions within their borders. Outsourcing contracts could be given to companies who are market leaders and focus in particular areas which will therefore achieve greater economies of scale which will obviously reduce costs significantly. These cost savings will allow for competitive advantages as it will allow for price reductions of products and services.
- High level of expertise - Outsourcing will enable a service or function to be completed by a company, or indeed a country (India for IT professionals) with extensive knowledge in that specific field. This expertise and knowledge will allow for improved service / product quality / increased capacity. Risk management can also be a benefit as it can provide mitigation. The use of external knowledge allows for increased innovation which it would be limited in house, as discussed previously increased capacity is possible due to outsourcing, this increased capacity could be used to accelerate the development or production of a product therefore reducing the time to market.
- Outsourcing allows for focus on core business activities.
- When a product or service is outsourced it is normally possible to scale up or down a particular function as necessary without any significant costs.
- Outsourcing allows small companies to merge a particular function which will enable them to compete with large corporations or even allowing the acquisition of applications at the right price.
- An outsourcing agreement is often a catalyst for change for a business. Companies are regularly are not go proficient at change, whether it implementation new technology, reengineering or changing their business, it is often time consuming and expensive and often the proposed goals are not met. Many forward thinking businesses are starting to treat outsourcing as change management tool which drives major enterprise level transformation, such as a shift in stock price, competitive position or a major increase in market share.
Reasons not to outsource:
However resourcing is not only beneficial to a business there are a number of disadvantages which is discussed in this section;
- Quality - when outsourcing a product or service to an external company it is important for the company outsourcing to remember that the outsourcing companies objective is often not quality but profit related for example quality fade is a well known strategy in increasing profits for companies which have been outsourced too, quality fade is a secretive and deliberate reduction of labor which widens profit margins, this downward change in human resources are subtle but progressive and is initially not noticed by the outsourcer or customer. This is normally achieved by a steadily decreasing skill level of the work force this causes decreased customer satisfaction and it will prove necessary for the outsourcing company to do regular quality checks and customer satisfaction surveys. The location of the outsourced functions / service therefore becomes an issue as it would be critically important to observe and evaluate the service first hand and have regular communication with the company in which has the contract. It is important that the contract is detailed as is it often hard to dispute differences. It is also important to remember that technology plays an important role it all functions so when choosing a company it is important to assess the technology currently used and if they regularly invest in new technology as this will affect capacity and market competitiveness.
- Staff turnover can be extremely high for an outsourcer particularly for call centre operators, which of course will affect the service provided to customers. This means that as the workforce decreases there will be a loss of skills and it is therefore necessary for the organisation to provide more regular retraining which is again costly and time consuming. It is also sometimes the case that a company will have to replace its entire work force.
- Language skills, are partially important in call centre's, as staff are in direct contact with customers, it is not only important that employees at the call centre's speak the same language as customers, but also for staff to understand different accents. From research it is proven that effective communication is impacted by perceived similarity between the customer and the customer service representative, it is also thought that people tend to prefer to interact with those similar to themselves ((Market Lett (2008)), many call centre's particularly in India encourage staff to be aware of what is happening in the country where calls are made and even the current story line in television shows such as Eastenders, an example which was well publicised, but still the majority of companies with outsourced call centre's abroad, can expect a decrease in customer satisfaction.
- Security - Before business functions are outsourced to a external company, a business is liable for their staff and actions made by them, including what data they are authorized to access, however when outsourced the responsibility transfers with the execution of the contract, information particularly regarding technology and competitive secrets is very important for any company to keep secure and when it is necessary to share information with external companies, it is more likely that this information will be shared with competitors, though of course it is necessary to assess what information is shared and the majority of the time it is not necessary to share sensitive data as business functions requiring this information is unlikely to be outsourced. It is possible for businesses to become vulnerable to coup by former business partners when outsourcing. Though the following example is not IS related I believe it demonstrates what Information system companies are risking when they outsource key functions, Blaupunkt a German electronics business wanted to add to the production line, VCRs were added and contracted out to Panasonic (then a lowly circuit-board packer),now with Blaupunkt reputation attached to it products, dealers were approached directly. Which meant that Panasonic had a readymade distribution network to go with it production line, so basically Blaupunkt gave access to its dealer network to Panasonic and they made it there own.
- It is important that every business uses every means to receive information, such as customer opinion, the market condition and competitors, "Clients always use the service provider's ability to achieve formation as a key selection criterion. It is always in the top three and is sometimes number one." [2009, Mr. Couto, Booz and Co] While failure is sometimes attributed to vendors overstating their capabilities outsourcing and suppliers promise to retrieve and pass on information this often fails to materialize, Couto points out that Clients are unwilling to invest in transformation once outsourcing is in place. [Bray, P (2009) Mutual aspiration]. To summarise it is possible to receive information when outsourcing, but even if you select a company carefully, the quality, and reliability may suffer, particularly in the long term.
- There has been strong public opinion and bad press, particularly regarding overseas outsourcing over the last decade; it is difficult to disagree with employees who have been made redundant in countries such as the USA and the UK so the organisation can employ cheaper labor from a foreign country, just to reduce costs. Sympathy will be widespread and may cause a reduction in sales An example of this is Barclays bank axing 1,800 Information Technology jobs in the United Kingdom, as part of a vast company overhaul to setup IT centres in offshore locations throughout the globe, including India where up to half of new employees are expected to be situated eventually because of a £450m IT outsourcing deal with Accenture. As you would expect this was a massive story in the British press who focused on the ethical issues involved, later in this report, a similar story using IMB as a example is also focused on.
- From the standpoint of labor outsourcing is a threat, which leads to feelings of insecurity, which may cause moral problems and will eventually lead to the loss of performance, it is important to note that staff have the tendency to resist change, particularly unwanted change.
Why has India become so popular in being an outsourcing destination?
IBM is one of the key outsourcing companies in India, according to the economic times it has approximately 36% of the market share and has been awarding outsourcing contracts worth between $500 million, and $1 billion, in this section the reasoning for companies such as IBM to use India for an outsourcing destination is analysed.
India's growth in the Information Technology industry has been of great significance to the IT community around the globe. In IS, India has developed a valuable brand equity in the global markets. In IT-enabled services, India has become the most favored destination for business process outsourcing, and is an important factor of growth of the services sector and the software industry. India's most valued resource in today's knowledge economy is its readily available technical work force. India has the one of the largest English-speaking scientific professionals in the world, the success of Indian IT firms and professionals is also due to India being a preferred destination for IT education, and labor is not only skilled but also relatively inexpensive compared with countries such as the United Stated and the United Kingdom.
The bar chart shown below in figure 1, shows the wages of two jobs advertised in the UK and India; it clearly illustrates the dramatic difference in the wages in the two countries in a comparison of the annual wages between both identical jobs. The advertisements are for call centre and a data entry employee, both could be easily outsourced, the comparison is made using jobs in jobview.monster.co.uk and jobs.monsterindia.com and uses the exchange rate on the 29th March 2010 from XE.com.
Why has outsourcing suddenly become popular?
While researching and writing this report I have started to wonder why in a relatively short amount of time, has outsourcing become so popular? After all the majority of the advantages have always been around for example; that there has always been countries with weaker economies and with a lower average wage, the only thing I believe has changed is gaining nations with an abundance of a particular skill, such as India, in this section possible reasons of this are discussed. The internet of course is the biggest factor in the increase in the number of companies outsourcing, it provides a method to communicate quickly and efficiently, which is very important in outsourcing, technology is also improving consistently and with the use of the internet can provide a significant tool, the following are a number of these tools which can be used in aiding communication; Video conferencing is a meeting between two or more people located in different locations anywhere in the world and they can hear and see each other using sound and television equipment. However this has been improved recently as it proved to be unreliable and many users find it impersonal due to the difficulty in "connecting", this is because of an inability to read facial expressions, video delays resulting in jerky images, inadequate audio quality, an inability to interrupt and otherwise interact naturally and finally it is generally complicated to setup which discourages use. Due to these draw backs Cisco Systems along with the help many of its associates has developed Telepresence which helps the collaboration between businesses. Telepresence uses the same concept as video conferencing but with a number of improvements to eliminate many of the disadvantages; the product is designed so that all members feel like they are positioned around the same table. The images are displayed life sized on high definition televisions. The sound is of the highest quality and the directionality of the audio appears to emanate from the location of the person speaking at the same volume as it would be heard if that person were actually sitting across the table, add imperceptible transmission delays and user-friendly interfaces makes the ideal tool in communication between the company outsourcing and the business with the outsourcing contract. The development of technology such as telepresence will enable companies to save money on expenses such as travel costs, it is important to remember that smaller businesses may find some of this technology too expensive.
Another reason for the increase is globalisation; for centuries, contact between the different civilisations throughout the world has become progressively closer, in recent times, the rate of global integration has radically increased. Unparalleled developments in technology transport and communications meant the process has given increased momentum. Large corporations produce products in many nations and sell to consumers throughout the globe. Wealth, technology and raw materials move progressively swiftly across borders, ideas and cultures interact increasingly freely. As a consequence, social movements, laws and economies are forming at international heights.
What is the future of outsourcing?
When researching the question of "is outsourcing going to continue to grow and be a business strategy long-term, the "experts" are divided;
Many believe outsourcing will be prevalent relatively short term this confirmed with recent results of satisfaction surveys. A survey carried out by Compass revealed outsourcing often makes both the vendor and the buyer unhappy. It also it announced that only 25% of project goals are fulfilled, this percentage is confirmed with similar results from other surveys; an analysis on German companies by Steria Mummert, discovered that over 50% of their outsourcing projects were unsuccessful. The companies have the opinion that the goals associated with outsourcing have not been successful and many of the studies recognise that the problem is that the expectations of the buyer are different from the vendor and businesses underestimate the complexity of outsourcing management. Many businesses continue to realise the benefits of outsourcing, however due to previous experiences by themselves and other businesses use in-house solutions as they are cautious about losing control and the number of other risks associated with outsourcing, businesses if participating in outsourcing will look to cancel contracts as soon as possible and are unlikely to outsource in the future.
The United States has developed "a tax code that says you should pay lower taxes if you create a job in Bangalore India than if you create one in Buffalo, N.Y" (Obama 2009), President Obama is thinking about changing tax laws in the United States to increase taxes on companies who outsource abroad and though this change needs to be approved by Congress, the US (a nation with one of the largest number of foreign outsourcing companies in the world) are sending out a clear message to companies who outsource, "we are unable to stop you outsourcing to companies in foreign countries but it will cost you", it is still unclear how much the proposed tax change will cost firms, but it may not be financially viable to continue to outsource overseas and I believe it will only be a matter of time before other countries governments will follow Americas example.
Other reasons that may prevent outsourcing to continue to be a success are the bad press it continues to receive, it may be just a matter of time before businesses give up to public pressure in their native country, it is also the case that wages are increasing in countries like India, though still drastically lower than countries like the US and the UK, perhaps they will be on a par relatively quickly.
However many outsourcing professionals believe this is only the beginning and popularity of outsourcing will continue to grow for the following reasons; Companies, both those who outsource functions and those who provide the service continue to learn ways of collaborating more effectively and achieving ways of fulfilling one another's goals and are developing best practice measures such as: the measurement of result, one point of contact in the organisation for the vendor, clear definition of roles and responsibilities, distinguishing them between the buyer and the vendor, precise definition of outsourcing goals and objectives and control and continuous improvement in the area of outsourcing transactions, communications and management activities.
There is naturally an alternative to outsourcing, which may prove to be the long term strategy of companies; however only large corporations are able to adopt it. Shared services is the consolidation of core business processes by separate departments within an organization. Shared services could be described as "internal outsourcing," and enables businesses to accomplish economies of scale by the creation of an individual internal entity within a corporation to perform specific services, such as the information technology department. Regularly shared services initiatives take advantage of enterprise applications and other technological improvements, allowing the business to achieve improvements to quality. The inspiration of shared services is the notion that innovative technologies offer companies the prospect to make superior use of scarce skills, decrease expenditure of administration, and the increased efficiency of the provision of information and services. This allows the delivery of improvements of both effectiveness and employee/customer experience by simplifying, consolidating service provision and standardising. However the adoption of shared services entails a titanic culture change for a business as the entire company context must be amended, it takes time, effort and management resources to move from a state of mind of decentralized management of support functions within each business department or centralized management of support function at the corporate level to the mindset of partnership between business departments and the consolidated, shared service organization.
An example of a Shared Service business model is shown, this diagram shows how shared services is formed from both decentralized and centralized functions.
During research in this area, there was a number of articles on a book called Vested Outsourcing by Kate Vitasek, published January 2010, in these articles experts stated the methodology described may be the template for businesses to achieve successful outsourcing in the future using five rules, Vitasek has also identified the top 10 crucial, regularly invisible flaws inherent in the majority of outsource relationships. Though I was unable to read the book, as the book seems to be acclaimed by a number of academics in the field of outsourcing I believe Vitasek may have produced the much needed methodology which had been missing, which will help eliminate some errors currently made by companies.
How to Outsource
Outsourcing is among the most significant business strategies and has developed to more than a cost cutting tool, but it also a means of achieving goals efficiently and rapidly, maximizing your workforce so you gain market advantage. It is therefore essential to select the right business partner which will fulfill all necessary goals, it is essential to analyse the functions of what is to be outsourced and what will be accomplished from outsourcing, once this has been defined you need to find a flexible organization that is capable of delivering the goals. It is necessary to narrow the search to a limited number of companies and then issue a request for proposal (RFP) and effectively tender for the job. This allows the flexibility to fully understand the organizations capabilities and review all costs before the final decision on which organization to choose is undertaken. Once this decision has been made negotiations proceed and a draft contract is produced, this is a critical stage and has to be completed correctly, to achieve this it is important that all elements are included and are unambiguous otherwise there could be huge implications in the future as if there a disagreement or the company is not fulfilling the functions to the quality expected, the contract is used to resolve the problem. It's essential to define the requirements of the proposed venture in terms of;
- Process-related requirements; including knowledge transfer, quality process, status reporting.
- People-related requirements; including the size of the team, skill level of staff.
- Business continuity requirements including data theft, virus attacks, and manmade and natural disasters.
- Security requirements including network, personnel security.
- Infrastructure requirements including; network, software, hardware details.
- An important section of the contract specifies the service levels, any incentives including bonuses clauses.
- The governance of the contract includes terms of contract breach, governing clauses termination clauses, contract breach and governing clauses.
There are three categories of contract between customers and the provider, the first is Labor based contracts, which is when different skill levels are assigned an hourly or monthly labor rate, the contract anticipates the general volume of work and the service goals, however in this sort of contract there is little incentive for the provider to improve efficiency, as the result would be less billable hours and therefore less revenue. The second category type is Transaction based contracts which are when the service provider is paid for completed work. There are normally service quality goals and anticipated transaction volume. This contract type will encourages a more efficient process. The final type is Goal based contracts, where both parties work together to establish goals, which encourages improvements. Both the service provider and customer can mutually examine effectiveness and efficiency initiatives, assess the potential impact, and distribute any benefits.
When written correctly the contract should also form the basis of a successful relationship. Once the contract has been signed by both parties there would be a transitional period when the project is handed over to the service provider, extensive formal training will be undertaken including both organizations which will also act as team building so that the organizations can integrate with each other.
Outsourcing and IBM
Whilst carrying out my research I realized that outsourcing was an extremely important area of IBM's business strategy, in the following section I will review the positives and negatives IBM has discovered with its strong relationship with strategic outsourcing.
IBM or Big Blue which it is often known as was founded in 1896 as Tabulating Machine Company and then incorporated in 1911 as Computing Tabulating Recording Corporation and was then listed on the New York Stock Exchange in 1916 by George Winthrop Fairchild. In 1917 CTR's Canadian and later South American subsidiary was named International Business Machine (IBM) and the whole company took this name in 1924. In 1935 IBM's first corporate trademarks `THINK' was filed in the US. Today IBM has an annual revenue of $95.8 billion, a net income of $13.4 billion, total assets of $109.0 billion and 399,409 employees worldwide.
IBM manufactures and sells hardware and software and offers infrastructure services, consulting services and hosting services in all areas of information technology from main frame computers to nanotechnology.
IBM are the world's largest business service provider and also outsource business function to external companies particularly in India where they have been constantly present since 1992 after initially starting their relationship in the 1970s, IBM is continually expanding in India and has its regional headquarters located in Bangalore and offices in 14 cities. Today, it is acknowledged as one of the leaders in the Indian IT Industry.
During research I located an interview by Randy Walker IBM's head of outsourcing, which I believe gives a unique incite in to IBM's outsourcing strategy. During the interview Mr. Walker stated the most significant reason to outsourcing isn't how much money it saves, but the value it adds. For example businesses currently looking at India to outsource purely to save on costs (which was the main reason when outsourcing first became popular) are overlooking the real benefits, performance and processes innovation. Now countries like India do not just offer 'cheap' labor it offers 'value'. Mr. Walker also explains how IBM's team in India is very service-orientated and is empowered to do many tasks including helping with any disgruntled customers. Mr. Walker explains when an Indian company signs a contact, IBM do not want a customer relationship, but treat the company as a strategic partner.
Mr. Walker however did not discuss some of the negatives of IBM's current strategy; though IBM's financial performance is almost unrivaled in the information technology sector, even being relatively successful through the current recession, but many believe that this feat has come at a too higher cost for the staff and customers, as many US staff have lost their jobs and there are reports that IBM are constantly missing deadlines and deliverables fail to perform as promised and many predict problems in 2010 with customer satisfaction.
IBM have made tens of thousands of United States employees redundant over the last decade, and have suffered from bad press over the years from these redundancies, as many suggest that the redundancies are due to outsourcing to India.
Disgruntled employees have started Alliance, IBM's pro-union group, who have been fighting outsourcing for years as it is believed to be the main reason for the redundancies as the now vacant jobs are being outsourced overseas to India etc. "IBM is clearly outsourcing things where they can," said an IBM member of staff who recently received his redundancy notice, he also noted that the customer support team once had fifteen United States based workers and it had been reduced over time to only three workers in the U.S., with other employees of the customer support team now located in India, Brazil and Argentina.
The employee noted that he received no good reason for his layoff. "Higher ups made a decision that a certain percentage had to be cut - it was not performance-based at all," he said. Although the employee said he's uncertain about the job market. As of last October, IBM doesn't normally discuss job reductions other than to explain that they are in response to shifting customer needs.
"IBM employees are being dealt a double blow", said Lee Conrad, national coordinator for Alliance@IBM"We're outraged that jobs cuts are happening in the U.S. and the work is being shifted offshore," Conrad said. "This comes at the same time IBM has its hand out for stimulus money. This to us is totally unacceptable."
Of course the press in the US has written numerous articles on this and the IBM brand name is not as strong as it once was and it is hard to comprehend how this bad publicity will effect IBM long term, particularly in the United States.
There is no doubt that outsourcing is a key strategic tool, but it has to facilitated carefully, I believe it is important to select the company, which is not only based on price, but more importantly will fulfill your and the customers goals and expectations, I believe the selection should be made not with the short term but with the long term in mind.
It is essential that the outsourced function is managed correctly, with regular communication with the outsource partner and constant evaluation of products/services. It is as important to manage internal issues correctly for example a important benefit is that it regularly frees up managers, so they can focus on higher value activities, but many companies do not receive this benefit as many managers do not discipline themselves to use the freed-up time appropriately.
- http://www.research.ibm.com/irl/dirmessage.html IBM outsourced research center India
- Read more at http://outsourceportfolio.com/end-of-outsourcing