Managing an Information Technology Outsourcing Projects

1. Managing an Information Technology Outsourcing Projects Kathy S. Schwaig

2. Definitions of Outsourcing (many exist!) • downsizing company by reducing # of employees • sale of businesses & assets or vertical disintegration • unbundling the organization (i.e.. sale of physical assets and laying off employees) • loss of control • purchase of an externally produced good or service that was previously internally produced

3. Quotes • “Outsourcing takes over all information systems functions, much the way an outside company would manage food service or laundry” Elizabeth Gardner, Healthcare Industry • “Like shoppers at a fruit stand, companies are picking an apple here or an orange there until they have selected a menu of outsourcing services.” Bernie Ward (editor of SKY magazine)

4. Quotes (cont.) • “We look forward to the day when we can buy more and more of our hardware and software from third-party vendors capable of tailoring their systems to our needs…Our skills as electronic tool builders, honed over decades, will become less and less decisive to our information strategy. This may sound like bad news, but we welcome it. We’re not in business to build computer systems.” (Max Hopper; American Airlines, 1990)

5. Outsourcing Options • Body Shop: • management uses outsourcing as a way to meet short term demand. Ex. contract programmers • Project Management: • management outsources for a specific project or portion of IS work Ex. use of vendors to develop a new system, support an existing application, handle disaster recovery, provide training, manage network • Total Outsourcing: • vendor in total charge of IS work Ex. commonly hardware (data center & TC) “keys to the kingdom”

6. Questions? • Is IS an homogeneous product? Utility? • proponents of outsourcing think so • If this is true, what could the IS organization of the future look like? • limited in-house IS • skills of CIO change from managing information systems to managing contracts

7. Transaction Cost Theory (Williamson) • Costs are comprised of both production costs and transaction costs (monitoring, controlling, managing transactions) • Thus, managers consider both production costs and transaction costs when making make-or-buy decisions. • Markets provide cheaper production costs than hierarchies through economies of scale but companies incur higher transaction costs.

8. Transaction Cost Theory (Williamson) • With hierarchies, companies incur higher production costs because an individual company cannot achieve economies of scale internally but would incur lower transaction costs. • The most economically efficient choice is a trade-off between production costs and coordination costs

9. Transaction Cost Theory (Williamson) • Transaction Types • frequency • asset specificity: degree of customization of the transaction • site: transactions available only at certain locations and can only be transported at great expense (EX. moving workers) • physical : equipment; EX: special production line configurations • human: specialized knowledge, training, etc..

10. Transaction Cost Theory (cont.) • When only production costs are considered, markets are more efficient than hierarchies due to economies of scale • When only transaction costs are considered, hierarchies are more efficient than markets due to internal control mechanisms that prevent opportunism.

11. Transaction Cost Theory in an Outsourcing Context • When approaching an outsourcing decision, managers must consider two types of costs: production and transaction. • Production: • Williamson would argue that outsourcers often achieve economies of scale that elude smaller, internal IS shops. • however, only for products that are standard (utility view of IS) • Which IS functions are standard?

12. Transaction Cost Theory in an Outsourcing Context (cont.) • Coordination Costs • Williamson would say that outsourcing causes higher coordination costs because the customer must monitor a vendor’s behavior. • costs are higher particularly if only one vendor is available • In order to reduce coordination costs, the customer should pay particular attention to contract details.

13. Political Model (Marx & Weber) • Power (sources of) • authority: power is a structural phenomenon; legitimizes power • resource acquisition • dependency & low substitutability: offer something of value • uncertainty (lack of information) absorption

14. Political Model (cont.) • Political Tactics: employed to influence decision • selective use of decision criteria • selective use of information • use of outside experts • building coalitions

15. Political Model in an Outsourcing Context • Model suggests that we focus on the power of the IS department, the vested interests of different stakeholder groups and the political tactics they may enact to influence a decision. • Can IS managers make objective sourcing decisions? • Can vendors submit realistic bids or will they plan to cushion profits by charging clients excess charges after the contract is signed? • Did any stakeholder groups selectively choose decision criteria or information to sway the outsourcing decision? • Did any senior executive possess so much power that a unilateral decision was made without consensus?

16. Theoretical Summary • Both theories presume that people act in their own self-interest • Transaction Cost: people within companies band together to compete against other companies • Political: people within companies band together to compete for resources such as budgets, promotions, and rewards

17. Forces Favoring Outsourcing • Need for organizations to focus on their core competencies • production, sales, finance/accounting • Realization of greater economies (lower costs) • Vendors argue that they can recapture scale because they can specialize in IS and lower costs because of volume discounts, sharing of resources and expertise, etc. • savings are partly passed on to customers (theoretically, at least!)

18. Forces Favoring Outsourcing (cont.) • Need for greater flexibility and expertise in workforce • outsourcing makes available to the organization the value-added specialized knowledge that the agent (systems integrator) brings to the transaction • flexibility is gained in that the organization does not have a long term commitment to these employees • Bandwagon effect • Everyone else is doing it and we’ll look like we are not with it if we don’t also (mimetic or imitative behavior)

19. Forces Cautioning Decision-Makers away from Outsourcing • Loss of Strategic Assets • IT frequently represents the ability to lead the industry and thereby to change the structure of the industry. Should that strategic asset be traded away or lost control of? • Managers who do not realize that IT is a strategic weapon are more likely to trade this strategic asset. Tom Thumb case is a classic case of such an oversight.

20. Forces Cautioning Decision-Makers away from Outsourcing (cont.) • Do not realize greater economies (actually higher costs!) • Vendors argue that they can recapture scale, but if the contract overly favors the outsourcer, the organization may pay more than if the function were insourced. • Lose “loyal” workforce • Even if the vendor hires your best people, he may put them on other accounts to attract new customers • OR, if you outsourced to get vendor’s expertise you may just be getting your own

21. Forces Cautioning Decision-Makers away from Outsourcing (cont.) • Cannot readily access or utilize increased systems expertise • the experts on your system now belong to the vendor • Threat of Vendor Opportunism • Extreme outsourcing (selling assets, people, etc) puts you at the mercy of your vendor • to start over, you would be at “ground zero” • vendor charging excess fees the client thought were covered

22. Forces Cautioning Decision Makers Away from Outsourcing (cont.) • Cost Savings might have been achieved internally • Large companies that operate at 150 MIPS (million instructions per second) should be able to achieve economies of scale on their own. • In-house data centers can automate and streamline operations and invest in new productivity-improving technologies just as outsource vendors do. • implement a charge-back system

23. Managerial Guidelines • Assess the strategic value of current and potential IT assets • Ensure (through contract) that these assets will not be traded away or lost through unbonded outsourcing • bond the agents (outsourcers/systems integrators) legally to ensure that the firm will not suffer loss of trade secrets. • bond the agents through insurance to recover from losses through non performance of contract

24. Review Questions • Give a working definition of outsourcing. • Explain how Transaction Cost Theory applies to the outsourcing decision. • Explain how the Political Model applies to the outsourcing decision • What are factors favoring outsourcing? • What are factors mitigating against outsourcing?