Extreme outsourcing: Does it work?

With the end of the Cold War and the subsequent consolidation of the US defence industry, defence contractor General Dynamics knew it would have to rethink its business - ever since, it has outsourced almost all its information technology functions. Why does it maintain such large-scale outsourcing?

With the end of the Cold War and the subsequent consolidation of the US defence industry, defence contractor General Dynamics knew it would have to rethink its business, including selling off business units. Such sales would be easier if IT was entirely outsourced, which prompted the Virginia-based company in 1991 to take 2500 IT employees and transfer them to Computer Sciences (CSC).

Ever since, it has continued to outsource almost all its information technology functions. Why does it maintain such large-scale outsourcing?

"It really works," says Ken Hill, General Dynamics' vice-president of IT.

Is General Dynamics' experience an anomaly? Does extreme outsourcing - defined as having at least 50%of IT functions outsourced - really work?

Unfortunately, there's little consensus among observers.

A study of 116 companies by US university professors Mary Lacity and Leslie Willcocks suggests extreme outsourcing doesn't usually work. Of the three outsourcing categories into which the study places companies, total outsourcing was the least successful. It succeeded at only 38% of the organisations that tried it, with 35% reporting failure, and 27% reporting mixed results.

When the opposite was studied - total in-house sourcing - the results differed markedly.

In-house sourcing succeeded 76% of the time, twice as often as total outsourcing, and failed 24%. The best results (by a small margin) came from those doing selective outsourcing, where 15% to 25% of the IT budget is under third-party management. It succeeded 77% of the time and failed 20%, with 3% reporting mixed results.

Lacity, associate professor of management information systems at the University of Missouri in St Louis, attributes the poor showing of total outsourcing to the difficulty of predicting the future. "It's very hard for a company to know what it will need over the long haul," she says. "What they wanted in the first year can dramatically change by year two."

Having only one supplier can also be a showstopper. "The lack of competition [between suppliers] creates a lack of incentives to overperform," she says.

Lacity isn't the only sceptic. "We now know that extreme outsourcing is quite dangerous. Extreme anything can be dangerous," says Eric Clemons, professor of operations and information management at the Wharton School in Philadelphia. Control, or lack thereof, is really Clemons' concern: "You lose day-to-day control, even the ability to get a good contract later. The more extreme your outsourcing, the less information you have for really specifying anything."

Stephen McClellan, a San Francisco-based computer services industry analyst at Merrill Lynch & Co, notes another risk: "You're locking yourself in with a vendor indefinitely, usually 10 years. It's even more of a locked-in arrangement than getting married. It's a bit of a one-way street."

Sometimes, the issue is more a matter of perception. "What is considered a success for one company is a failure for another. A third company might call it a working solution because no one wants to own up to the fact that it's not working," says Stan Goldman, president and CEO of Technology and Business Integrators, a strategic IT and management consulting company in New Jersey, which conducted a study of outsourcing in 1997 with research firm International Data (IDC).

The successful

But extreme IT outsourcing does have a few success stories.

In 1997, chemical giant DuPont outsourced 75% of its IT people to CSC and Boston-based Andersen Consulting. "One of the things that impresses me is [that] the work's getting done," says Robert Ridout, CIO and vice-president at Du Pont Information Systems. Previously, Du Pont had about 200 IT vacancies it couldn't fill. CSC and Andersen have been able to fill those jobs.

Du Pont also points to improved success in projects. It labels projects "red" (there's a problem), "yellow" (needs watching) and "green" (going well). During the year before the outsourcing deals were made, 5% of projects were rated red, 23% were yellow and 72% were green. Today, 2% are red, 11% are yellow and 87% are green.

Another improvement lies in the efficiency of Du Pont's transactions done via its SAP system. Though they've increased 50% during the life of the contracts, those transactions are being completed faster - 98% are being completed in less than a second, up from 88% before the contract was signed.

"And we use hardware a lot more effectively, so our operating costs went down about $US700,000," Ridout says.

Andy York, acting director of information systems at shipbuilder Bath Iron Works, a General Dynamics subsidiary in Maine, says that since his company began outsourcing with CSC, desktop software and hardware deployment has improved about 33%, and cost savings have reached the company's expectations (though York won't reveal what the savings are).

Bath has outsourced virtually all its IT functions; its staff has fallen from 140 all the way down to three.

Careworks of Ohio, a Dublin-based managed care organisation founded less than three years ago, outsources half of its IT functions to Ohio-based Medical Mutual. Its goal: to get up and running faster to take advantage of market opportunities. "We were a start-up company entering a large market with a large volume of bills that had to be processed, and for us to do all the programming ourselves would have taken a significant amount of time and resources," says chief operating officer Rich Poach.

Dan Mummery, a partner in the global technology transactions group at New York law firm Milbank, Tweed, Hadley & McCloy, says evidence that extreme outsourcing works is simple - people keep doing it.

Making extreme outsourcing successful

Companies that have enjoyed success with extreme outsourcing have taken steps that helped assure a desirable outcome. Poach says defining up front what will be provided and when and how it will be provided is essential.

Also, establish specific metrics. "Define, 'Here's what I'm buying, here's how I measure results'," says Peter Bendor-Samuel, president of consulting and software company Everest Group in Dallas. Performance metrics to consider include things such as processing speed, volumes and time lines for implementation.

Some functions tend to be more successfully outsourced than others. Goldman says outsourcers are good with day-to-day repetitive tasks, but not with implementing bleeding-edge technology.

Those who are successful "focused on infrastructure, which is 80 % of [an] IT operating budget", Lacity says. "Infrastructure is a lot easier to outsource than application development."

"You have to have common goals. If [the customer's] goal is to reduce head count or lower overhead, I can't have goals that are obstacles to that," says Mark Dieterle, vice-president and account executive at CSC who handles the General Dynamics account.

Cynthia Murphy, senior analyst of outsourcing at IDC, gives the following recommendations for success:

q Do your homework ahead of time.

q Find the vendor that is the best fit for your company. Consider things such as track record; expertise; its record with companies your size and with companies in your industry; and whether its contracts have been renegotiated (find out why). Check out its employee turnover, too. You could get into trouble if you sign a 10-year contract, and the vendor's employees who worked with you on the contract all leave six months later.

"I get a fair amount of calls from other companies which have done sourcing, and their deals aren't going so well," Ridout says. "I think, generally, the problem is they prefer not to be as involved in managing [the deals] as they need to be. You have to have really good people to make sure that you're managing the right things. Mainly, you're talking about the 'what needs to be done' and not the 'how'."

Extreme outsourcing makes the procedural problems more complicated, according to New York-based negotiation consultant Elizabeth Gray, who has worked with Eastman Kodak and other companies on their IT outsourcing arrangements.

The more complex a deal, the more attention you must pay to the working relationship with the outsourcer and to managing that relationship, she says.

Finally, create a win-win-win situation. Joe Randazzo, a senior director responsible for vendor management at a major Wall Street firm, says each outsourcing deal really has three parties: the company that's outsourcing, its employees who will be changing employers and the vendor. They all have to win for the deal to work.

Extreme outsourcing often doesn't work. If you decide to take this path, be certain you know what you want to accomplish and why, and how you plan to get there.

Horowitz is a freelance writer in Salt Lake City. Email alan@ahorowitz.com.

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