Alignment and Outsourcing – Part I

How to align business and technology objectives when large-scale outsourcing exists

As a follow-up from the previous post on Fields of Alignment, here is the continuation of the subject for one of our fields – Alignment and Outsourcing Strategy. In this post, I explain the impact of the outsourcing strategy on an organization and the objective is to contribute to the research body of literature by relating two different conceptual models (SAM/mSAM and Decision cube for IT sourcing engagements) as an entry point into the development of theory.

There are five forms of IT sourcing: (a) insourcing, (b) selective sourcing, (c) strategic alliance sourcing, (d) outsourcing, and (e) off-shore outsourcing. While the insourcing relies on in-house resources, the other three types of outsourcing use resources external to the organization. Selective and strategic alliance sourcing are established on multiple suppliers and on joint venture partners respectively. While outsourcing predominantly uses resources external to the organization at a local or regional level, offshore outsourcing implies delegation of the selected business operations to an offshore location outside the country.

Information systems (IS) outsourcing (especially its offshoring aspect) as a special type of model began early in 1990 as a way to supplement in-house IT development activities. IS outsourcing became a growing economic phenomenon worldwide because of (a) the development of IT-related infrastructures in developing countries, (b) a surging demand for IT specialists in developed world, and (c) availability of a highly skilled pool of personnel in the developing world at a reasonable cost. Organizations that outsource their activities are expecting the following benefits: (a) cost savings; (b) increased rate of returns on investments, and, (c) improved access to best practices in IT design, implementation and operations.

The IS offshore outsourcing has some pitfalls if not well planned and implemented on both sides – client and vendor, and these pitfalls create client-vendor relationship problems. In addition to the problems mentioned, the three potential concerns related to privacy in information security raised by off-shoring data processing are the legal aspects, information security, and vendor reliability and dependability.

In September 2004, JP Morgan Chase, one of the world’s largest financial institutions (over $1.2 trillion in assets and the second largest U.S. bank) scrapped a 7-year, $5 billion IT outsourcing contract with IBM, as a result of a decision to bring back IT inhouse (insourcing). People who oppose outsourcing, especially offshoring, declared the “end of sourcing.” As a matter of fact, Adams, the CIO who led the process, said that his move was greatly misunderstood: “I am clearly an advocate of offshoring.” In the case of such a large bank, there was a reason for insourcing, which was mainly to get a better competitive advantage from IT, while in smaller organizations, Adams believed large-scale outsourcing is logical.

Here are some observations made by Adams:
• The work ethics, attitudes, and ambitions of the company’s employees in India are significantly higher than its U.S. employees.
• Outsourcing of major parts of mission-critical technologies is not a best solution for a large firm. Technology development should be in-house, while support services can be outsourced.
• Four criteria were used to determine what and how much to outsource: (a) the size of the company (should be large enough to attract good IS employees), (b) cost of outsourcing versus insourcing, (c) the interest level of top management to have and properly manage IT assets, and (d) financial arrangements of the outsourcing.
• It may be difficult to align business and technology objectives when large-scale outsourcing exists.
• The insourcing includes data centers, help desks, data processing networks, and systems development.
• Buying technology directly from vendors saved the bank a considerable amount of money (10 to 15 percent).
• Usually less than 5 percent of outsourcing contracts are canceled as in this case.
• The cancellation was driven mainly by the merger with Bank One, which made the combined bank very large.

There are advantages and disadvantages of outsourcing the integration of new technologies into the organization. Offshoring offers many advantages such as the focus on unique core competencies, exploitation of the intellect of another organization, and costs reduction. The main downsides of offshoring are security, lack of knowledge specific to the industry of outsource companies, languages and cultural barriers, government restrictions, and loss of control of IT assets.

Most companies enter outsourcing agreements without a good process discipline. This situation can lead to escalating costs, poor results, and difficulties managing the relationship. IS managers should know what, when, and how to outsource. They should be aware of the leadership decision-making regarding outsourcing and offshoring. In 1960, Simon published what must be one of the better-known models in the management literature, his model of decision-making. According to Simon, there are four different stages in decision-making: intelligence, design, choice, and implementation.

Whilst Simon’s model is general for decision making, some scholars and practitioners proposed adapted frameworks that parallel the decision-making process an organization supposedly goes through when evaluating its sourcing options and subsequent outcomes. These frameworks generally have two phases: (a) decision process (three phases of Simon model: why, what, which) and (b) implementation (how, outcomes).

In 2004, Dibber and his colleagues proposed a framework of IS offshoring decision-making process by identifying three variables that influence strategic offshoring decisions: (a) internal IS capacity, (b) IT services opportunity contemplated, and (c) potential strategic business values obtained from IT service. The internal IT capacity comprises commitment of top leadership, provision and deployment of infrastructure, pervasiveness and sophistication of use, technological and managerial skills. Discrete IT functions and end-to-end IT enterprise-wide solutions are the IT services opportunity being contemplated. The potential strategic business values to obtain from IT service are: service level, core competencies, alignment of goals, time to market, world class processes, industry on process knowledge, new business opportunities and overall competitiveness.

Discrete IT functions comprise (a) stand-alone functions (voice and data communication management), network monitoring and management, network services (LAN/WAN management); (b) desktop management (helpdesk, desktop support, asset management, imaging, and procurement); (c) data centers services (operation of mainframe, midrange, distributed systems, monitoring of systems performance, business continuity, backup and storage services, cloud computing and virtualization, information security and assurance); and (d) application service (application management, software maintenance and upgrades, systems operations management, problem tracking, etc.). End-to-end solutions include enterprise-wide solutions that add values to the organization.

Pati and Desai’s (2005) decision cube for IT sourcing engagements helps to determine whether or not an IT service should be outsourced. This model defines eight scenarios which guide strategic in-sourcing or outsourcing decisions. The two scenarios that guide strategic in-sourcing decisions are (a) a high level of internal capability for end-to-end solution engagement that has high strategic business values for the organization; and (b) a high level of internal capability for a discrete IT service engagement that has high strategic business values for the organization. Other scenarios favor outsourcing strategy.

I agree that most companies have outsourced some portion of their business to lower costs and over time, have achieved cost savings in the outsourced portion of the business. It is likely that this cost-saving mirage could not produce long-term benefits for a firm because it contradicts the purpose of alignment, information security, and knowledge management. The main economic driver for in-sourcing is the value associated with corporate knowledge. In the knowledge society, the value-creating strategies and long-term viability of a firm depend on sustaining its competitive advantage. Sustaining competitive advantage of the firm requires aligning IT to business in a secure environment by considering knowledge as a distinctively unique resource that should be managed.

Some References:

Dibbern J. et al. (2004). Information systems outsourcing: A survey and analysis of the literature. The DATA BASE for Advances in Information Systems, 35(4), 6-102.
Pati, N and Desai, M., S. (2005). Conceptualizing strategic issues in information technology outsourcing. Information Management & Computer Security, 13(4), 281-296.