Why Cost Alone Should not Dictate a Decision on Outsourcing IT


Whether or not to outsource IT functionality is a decision which is increasingly being asked around town. 

Many organisations have already outsourced their IT with second or third generation outsourcings increasingly common (at least in the US and Europe). With IT overheads coming under increasing pressure, CFOs can easily be tempted by the prospect of reducing head-count while CEOs look to increase the company' s focus on core activities.

These are the principal perceived advantages to a company which chooses to outsource its IT requirements. However, if the advantages are so clear, why hasn' t outsourcing in Asia expanded through the nineties to the extent that many predicted?

To a large extent this has been a result of the boom times, when everyone was doing well enough without outsourcing. Also, there has been a clear sense of trepidation on the part of local companies to hand over their IT functionality to third parties either because of concerns regarding confidentiality and other trust issues or due to concerns relating to performance and potential supplier dependence.

Whatever the current concerns are, the trend towards outsourcing appears to be growing. Dataquest Inc (a unit of the Gartner group) predicts that that the worldwide finance and accounting outsourcing market will grow from US$12 billion in 1999 to US$37.7 billion by 2004. This is not quite as ambitious as Dilbert' s prediction that "in the future, all work will be outsourced, until all the work on the planet is being done by one guy" , but it still represents a huge increase in the outsourcing market.

In making a decision whether or not to outsource, it is important to concentrate on the underlying rationale for the outsourcing. This should generally be performance related - i.e. that a third party supplier can provide certain non-core services more effectively than the customer. Cost factors alone should not dictate whether to outsource, as a cost efficient business which does not perform is ultimately not going to be successful.

Also, in outsourcing deals more than with any other IT relationship, it is important to focus on the legal niceties. From the very start of the outsourcing project consideration needs to be given to the extent to which it is desirable and possible to transfer IT systems and employees to the supplier. Often there are contractual or other legal difficulties in undertaking such transfers which can become expensive to resolve if not dealt with early on.

Also, particularly from a customer' s perspective, the contractual documentation should deal with the following issues which are key to a successful outsourcing:

  • Service levels - These should be set by reference to an appropriate performance target and, if possible, they should be output based rather than set by reference to the solution chosen by the supplier.

  • Relationship management - It is important for the supplier to retain some technical skills so that it can interface with the supplier at an appropriate level. It is important that the contractual documentation sets out appropriate procedures for the parties to communicate, to deal with disputes and to amend the contract to reflect a relationship which will inevitably change through time.

  • Exit strategy - A common fear for customers is that they will become supplier dependent and that they will have insurmountable difficulties in either finding a replacement supplier or bringing their IT back in-house at the end of the outsourcing. This is a valid concern and it is essential to set out in the contract a detailed plan dealing with transfers for equipment, software and intellectual property rights so that, when the time comes, the parties can go their separate ways with the minimum of fuss.

There are many benefits which customers can realise from outsourcings, particularly in terms of being able to focus on what is core to their business and in controlling or reducing costs. However, these benefits will rarely be achieved unless sufficient effort is put into the relationship at the beginning.

An edited version of this article was first published in South China Morning Post on 6 October 2001.