Outsouring risks and rewards matrix
Over the years, Information Technology (IT) has grown and continues to grow rapidly. IT improves an organisation’s day to day work process, strengthens their competitive advantage and increases business value both effectively and efficiency. Many organisations are struggling with successful IT management of this relatively new function. Shortage of staff with necessary skills; demands for security; uptime applications being essential; have many organisations turning to outsourcing IT in order to reconcile these challenges. (DiRomualdo and Gurbaxani, 1998).
This paper will identify some of the risks and rewards to an organisation when outsourcing IT. Section 2 of this paper, will define outsourcing. Section 3 will define and acknowledge IT outsourcing. Section 4 will identify the rewards associated with IT outsourcing. Section 5 will identify the risks associated with outsourcing and Section 6 will suggest solutions to minimise risks. The method of research carried out to support this literature review is composed of desk top research, with analyse of numerous articles, journals, websites, blogs and vendor reports. As this is a short literature review, some areas will be discussed briefly.
Outsouring risks and rewards matrix Essay Example
Outsourcing Outsourcing is simply defined as ‘consisting in conducting one or more organisational activities, using external agents’ (Lacity and Hirschheim, 1993). It is in common opinion that outsourcing is in no way a new discovery. (Earle, 1996; Lacity et al, 1996) In the past three decades the use of outsourcing has dramatically increased, creating a gap in the market for outsourcing vendors. Several of the pioneering outsourcing vendors are not surprisingly from the IT sector. Lonsdale & Cox state this is primarily due to the fact that in areas where technology progresses fastest, the problem is the most serious.
IT Outsourcing IT outsourcing is defined as ‘the significant contribution of external suppliers in the physical and/or human resources associated with the entire or specific component of the IT infrastructure in the user organisation’ (Loh and Venkatraman, 1992). Gilley and Rasheed’s definition is similar but suggests IT outsourcing be part of an organisation’s strategy (2000). This is supported by Quinn, advising that having an IT outsourcing strategy can be an advantage (1999). From research, it is evident that there are many forms of outsourcing.
Offshore and selective outsourcings are best to acknowledge in relation to risks and rewards of IT outsourcing. Selective Outsourcing – where a company follows a framework similar to that of Lacity et al’s (1996) framework. Strategic decisions are made when selecting what part of IT to outsource and whom to. Selective outsourcing provides managers with a greater array of options when choosing approaching outsourcing. The literature on outsourcing emphasises the importance of choosing the right vendor. Often times the issue with outsourcing is in fact sourcing the right vendor, rather than the process of outsourcing (Willcocks et al, 1995).
Offshore Outsourcing – where a function is outsourced across borders or overseas. The majority of offshore outsourcing is to countries with a lower wage rate, but with just as adequate skill sets. This allows applications to be achieved at lower costs. Due to time differences, it can result in 24 hour business operational time, reducing production life cycle in half (Khan et al, 2003). The recent movement to outsourcing IT suggests that there are rewards to be gained. In the corporate world, risks and rewards tend to come hand in hand; but with risks there are usually ways to avoid them.
In the following two sections, some of these rewards and risks, along with solutions to avoiding them are identified. 4. Rewards associated with outsourcing With IT’s growth and rapid progression, many organisations are eager to reap business performance rewards from IT. Unfortunately, many don’t have sufficient knowledge of how to strategically combine their technical and business skills together to exploit technology. Many companies also have the attitude of only wanting to solely focus on business and not IT (Earle, 1996).
Thus, companies are turning to the IT outsourcing market as a solution, relying on the premise, that IT outsourcing vendors will be more cost effective and efficient of the task at hand (DiRomualdo and Gurbaxani, 1998). The following three rewards; cost reduction, quality improvement and ability to focus on core competencies; are examples of why organisations are outsourcing IT. Cost Reduction – Cost reduction is a common reward and objective for outsourcing IT (Earle, 1996; Quinn, 1999; DiRomualdo & Gurbaxani, 1998; Lacity et al, 1996). Quinn declares that properly developed strategic outsourcing lowers costs.
While Diromualdo and Gurbaxani claim that the growth in popularity for outsourcing stems from a primary focus on cost reduction. As the market for IT outsourcing expands, and changes in technology continue, more organisations are pursuing IT improvements, resulting in an increasing number of available market vendors. ‘As competition in the outsourcing market increases, companies have more power to bargain for shorter contracts’ (Lacity et al, 1996). DiRomualdo and Gurbaxani state that as the outsourcing of IT is to a company of experts in that area, it should be produced cheaper as such expenses like training staff, taxes, benefits etc.
are omitted (1998). Similarly, with offshore outsourcing in countries like India or China, there is significant cost reduction as they have lower wages & benefits (Khan et al, 2003). Quality Improvement – Outsourcing vendor’s offer clients more flexible and integrated services, than clients are able to produce themselves (Quinn, 99). “Outsourcing uses experts to provide competence and experience with technologies and resources, which have the ability to produce best in the world” (Ford et al, 1998; Gomes-Casseres, 1994; Knight and Harland, 2000; Lonsdale, 1999).
Use of modern technologies, have established links to global markets. Organisations now have the opportunity to outsource to vendors who are ‘best in class’ performers (Harland et al, 2003). Best in class’ vendors are current and innovative; influence the client to be likewise, introducing new technical skills, resulting in quality improvement for the client. (Quinn, 99; Diromualdo and Gurbaxani, 1998). Quality improvements from outsourcing IT, improves ‘infrastructure scalability and flexibility, administration time, security, and time to market’ (Savvis).
Focus on Core Competencies – Outsourcing allows firms to focus on their core competencies and activities. Outsourcing vendors manage their non-core work, which they do more cost effectively. A golden rule in outsourcing is to never outsource ones core competencies (Khan et al, 2003). It is of great advantage to an organisation to be able to prioritize outsourcing of activities which are not ‘best in world’, ‘60-90% of in house activities are services that aren’t being performed at best in world levels or contributing to competitive edge’.
Hence, there are only minor risks involved when outsourcing such activities (Quinn, 1999). 5. Risks associated with outsourcing Numerous papers highlight the risks of outsourcing, the majority are written to assist avoidance of these risks, rather than discouraging IT outsourcing. IT outsourcing, incorporates the client putting part of their business in the hands of another, so there are going to be risks. The following are the dominant four themes that appeared in papers; hidden costs, security, control and trust.
There are many other risks such as: culture clash, opportunism; where employee morale may be affected due to fear of job loss, loss of strategic flexibility, inexperience, lock-in, etc. (Lonsdale and Cox, 2000; Earle, 1996;) Hidden Costs – There are many hidden costs with IT outsourcing. These hidden costs often don’t become apparent until after contracts have been signed. Earle claims that there are two types of hidden costs (1996). Firstly, the underestimation of setup costs; like ‘redeployment, relocation, and longer-than-expected handoff or parallel running costs’.
These are usually due to undefined requirements in drawing up the contract (Gonzalez et al, 2005). Secondly, the underestimation of management costs ‘including contracting, costs relating to evaluating the right vendor, benchmarking services and legalities’. It can be impossible to specify desired outcomes especially in IT areas in advance, causing difficulty in estimating costs. (Quinn, 99) Security – Another risk is the issue of security; a breach in confidential information. There is always the possibility of the vendor selling or leaking client confidential solutions to competitors (http://www.
corpcomputerservices. com/articles/outsourcing-reasons; Quinn 99). Many companies are now outsourcing their IT storage, (most likely consisting of confidential information) so security is an issue that concerns organisations when outsourcing (Gonzalez et al, 2005). Similarly, while ‘interacting with vendors, clients could lose their competitive advantage as a result of the transfer of their key business or strategic knowledge to their vendor service. This knowledge transfer risk also exists when buyers maintain an alliance relationship with others’ (Gallivan and Oh, 1999).
To avoid these risks firms need to ‘retain some specific key knowledge in house if they really want the outsourcing relationship to work satisfactorily for the customer’ (Gonzalez et al, 2005). Control – Control is a risk that concerns many clients. There’s the possibility of losing control of an activity, including the skill being outsourced. In turn, there’s the possibility of becoming dependent on the vendor (Gallivan & Oh, 1999; Quinn 1999). ‘Loss of control can occur when vendors assume leadership for the IT relationship, thus limiting client’s autonomy.
Vendors take control of certain decisions and resources in the outsourcing relationship, to re-assert this – companies should form coalitions of similar buyers, such alliances can be effective to obtain power due to strength in numbers’. Organisations that outsource a large majority of their IT often fear the loss of control of their staff. The possibility of resistance from staff is higher when a larger number of employees are being affected (Gallivan and Oh, 1999). Trust – When there’s lack of trust between clients and vendors, performance can be affected.
Clients often distrust their capacity to strike a deal with the right vendors (Quinn, 1999). Often times when distrust is present, it can lead to finger pointing. Each organisation seeks to identify how the other may have damaged the project (Sabherwal, 1999). Clients may also lack faith in vendors’ dedication to the project, arguing that an ‘outside vendor will never be as effective as a full-time employee who is under the same management as other employees’ (www. corpcomputerservices. com/articles/outsourcing-reasons).
Creating a healthy vendor– client partnership builds trust, encouraging participants to work together. (Sabherwal, 1999; Gallivan and Oh, 1999). Toyota, believe in the significance of understanding the operations and culture of their outsourcing vendors, send executives to vendor locations to see and understand for themselves. This process is time consuming and costly, but proves to be valuable in building relations and trust between the vendor and client (Liker and Choi, 2004). 6. Solutions to Minimise Risks The following are suggested solutions that organisations should take on board when contemplating outsourcing IT.
In order to reduce initial risks in outsourcing, it is advised that risk assessment and management are part of the process, as they are important contributors to the success of an IT outsourcing project (Aubert et al, 1998). Risk management needs to be ‘holistic in its approach and accept that multiple approaches may be required if risks are to be avoided’ (Harland et al, 2003). It is important for outsourcing managers to be aware that no size fits all. Each individual IT outsourcing activity requires different approaches, in order for it to be successful (DiRomualdo & Gurbaxani, 1998).
Similar to Toyota and Honda, outsourcing management should create systems to measure the way their suppliers work, setting targets and incentives, and monitoring their performances (Liker and Choi, 2004). A close vendor-client partnership should be created. Clients should share their risks and gains with their vendor partner, resulting in a collaborative relationship that transforms ‘key business processes into competitive weapons at an accelerated pace’. ‘Risk and sharing reduction is a primary advantage in joint ventures, as potential for error due to inexperience can be reduced by engaging in co-sourcing alliances’.
It is important there is a balance between risk and reward for the vendor and the client. Partial ownership encourages vendors to continue performing ‘best in world’. (Linder et al, 2002; DiRomualdo and Gurbaxani, 1998). To avoid risks it is suggested; to set clear expectations within the contract, relentlessly drive performance improvements, pool vendor-client resources and work together, not against each other. Clients should encourage vendors to be innovative in order to ensure that their performance and value stay ahead of competitors