Transcript No Slide Title

Slide 1
MIT5312: Systems Analysis and Design
Outsourcing and
Offshoring
MIT5312: Professor Kirs
Slide 2
Outsourcing
Outsourcing is ….

A free market thing

A Special form of international trade (CES IFO Institute ,Germany)

A matter of polarized public debate

About your “core”

A question of trust

Unevenly dispersed on the globe (yet growing)

Generating fear (fear of change?- Cochrane,2004)

A relationship and arrangement

Partner quality

Subject to areas of high attrition ?
(ex-Call centers)
(European Foundation for ILWC,2004)
MIT5312: Professor Kirs
Slide 3
Outsourcing
Basic Terminology
• Outsourcing:
• Delegation of non-core operations from internal production to
an external entity. Sharing organizational control.
• Best Sourcing:
• Associating with the ‘best of the best’ (Tom Peters)
• Offshoring:
• Transferring Activities to another country by hiring local
subcontractors or by building a facility in an area where labor
is cheap (er).
• Nearsourcing:
• Similar to offshore (yet close distance)
• Insourcing:
• The opposite of outsourcing
MIT5312: Professor Kirs
Slide 4
Outsourcing
Why Outsource?
• Cost Concerns:
• It has been reported that more than 80% of European
companies engaging in Offshoring are satisfied with the
results, and that the cost savings realized have generally
ranged between 20% and 40% [UNCTAD, 2004].
• The average salary of an Indian programmer stands at $6,000
to $12,000. But, it's much lower in China at $5700 to $9000
• The pay range for agents at call centers in Mumbai is INR
8,000 to INR 15,000 per month, or $183.50 to $344 at current
exchange rates
MIT5312: Professor Kirs
Slide 5
Outsourcing
Why Outsource?
• Access to Specialized Skills & Expertise:
• India has over 2,100,000 English-speaking graduates are
added annually and 460,000 of them are IT grads.
• China has over 200,000 IT professionals and 50,000 new
graduates are added to the pool every year.
• China produces 52% of all Science and Engineering graduates
MIT5312: Professor Kirs
Slide 6
Outsourcing
Why Outsource?
• Access to Specialized Skills & Expertise:
• The United States has falling education standards
• The number of scientists, engineers, computer scientist and
other technical professionals has been falling in the United
States
• “Bill Gates recently said there's an insufficient amount of
skilled people in the U.S. labor pool. As he put it, "Anybody
who's got good computer science training, they are not out
there unemployed. We're just not seeing an available labor
pool."
MIT5312: Professor Kirs
Slide 7
Outsourcing
Why Outsource?
• Access to Specialized Skills & Expertise:
“In China today, Bill Gates is
Britney Spears.
In America today, Britney Spears is
Britney Spears
and that is our problem.”
Thomas Friedman
MIT5312: Professor Kirs
Slide 8
Outsourcing
Why Outsource?
• Lagging IT Performance:
• The performance gap is widening between organizations that
have achieved world-class performance levels in their back
office operations versus typical companies, with top
performers generating significant savings while delivering
improved effectiveness and reduced risk, according to new
research released by strategic advisory firm The Hackett
Group.
• IT might improve business processes, but capitalizing on this
improvement is out of control of the IT function.
MIT5312: Professor Kirs
Slide 9
Outsourcing
Why Outsource?
• Focus on Core competencies:
• Core competencies are the key skills, characteristics and
assets that your company brings to the marketplace. These
competencies, on an organizational level, are a synergistic
blending of the core competencies that your people
individually bring to work every day.
• Core competencies are "focus points" that funnel peoples’
skills and efforts to make a greater effect
• Aligning IT with the business is crucial to success, yet IT is
too often seen as a "support" service and is not included in
high-level decision-making.
• The core competency of the outsourcee is IT
MIT5312: Professor Kirs
Slide 10
Outsourcing
Why Outsource?
• And other reasons:
• Economies of scale
• Bulk Purchasing
• Better use of capacity
• World-class standards applied
• Improved control/standardization
• Flattening of Hierarchical Structure
MIT5312: Professor Kirs
Slide 11
Outsourcing
Why Outsource?

It is something you can’t (nor want to) avoidEven if we stop, our competitors wont.
CSIS Report

It is irreversible.

It is a product of free trade—it adds value to
shareholders.

Requires a society that can imagine and invent the future
demand.

Means we must go to high touch/high concept jobs
and away from high tech jobs
Daniel Pink
MIT5312: Professor Kirs
Slide 12
Outsourcing
Why Outsource?
Every Morning in Africa, a gazelle wakes up.
It knows it must run faster than the fastest lion
or it will be killed.
Every morning a lion wakes up.
It knows it must outrun the slowest gazelle
or it will starve to death.
It doesn’t matter whether you are a lion or a gazelle
When the sun comes up,
YOU BETTER START RUNNING!
African Proverb
MIT5312: Professor Kirs
Slide 13
Outsourcing
Why Outsource?
We aren’t going any
further until the
class comes up
with at least three
other reasons why
outsourcing is a
good idea.
MIT5312: Professor Kirs
Slide 14
Outsourcing
Some arguments for NOT outsourcing
• Loss of jobs:
• A University of California Study that estimates 14 million
U.S. white collar jobs - one in nine - are at risk.
• A 2004 report by Forrester Research suggests that a total of
3.4 million U.S. white collar jobs will move overseas by
2015, with 830,000 jobs leaving by the end of 2005.
• A Progressive Policy Institute report claims 12 million jobs
are vulnerable, with most paying more than the U.S. median
wage.
MIT5312: Professor Kirs
Slide 15
Outsourcing
Some arguments for NOT outsourcing
• Loss of control:
• "I've had people approach me and offer to save us money by
consolidating our technical support," said Monad.net
President George Scott. "But I think technical support is a
major competitive advantage. I therefore want control of that
-- I don't want to give it away."
• "Everyone knows that differentiation is the key in the ISP
business, and this also goes for dealing with the pressures of
handling technical support," said the operations manager of a
Massachusetts ISP. "No ISP is happy with the fact that they
have to handle so many calls from customers who are not
adept with their PCs, but we understand that handing them
over to a third party is the wrong business move."
MIT5312: Professor Kirs
Slide 16
Outsourcing
Some arguments for NOT outsourcing
• Concerns about quality:
• "You have to take a total business view of outsourcing
technical support," said the customer service manager of a
New York ISP who chose to remain anonymous. "And first of
all, you have to look at the overall importance of offering
quality technical support. When you're talking about capacity
and how much you can sell, you have to look not only at
technical capacity, but also your customer service capacity. If
you're selling within your technical capacity but over your
technical support capacity, you're in for ruin. Outsourcing
technical support is certainly an option, but it's not something
we would do."
MIT5312: Professor Kirs
Slide 17
Outsourcing
Some arguments for NOT outsourcing
• Social Impacts:
• "In the three years ending in 2003, more than 5.3 million U.S.
workers who had held their jobs for at least three years were
displaced," Outsourcing America states. "In January 2004,
only 65 percent of them had found full or part-time work, and
a third of the employed suffered a pay cut of at least 20
percent."
• A July 2004 survey in the San Francisco Bay area found 27
percent of those polled are worried about losing their jobs.
"Economists could attempt to estimate the lost wages and
benefits from unemployment and reemployment at lower
salaries, but there is no way that they can calculate the costs
extracted from individuals, their families and their social
networks."
MIT5312: Professor Kirs
Slide 18
Outsourcing
Some arguments for NOT outsourcing
• Hidden Costs:
• The Cost of Selecting a Vendor
• “With any outsourced service, the expense of selecting a
service provider can cost from .2 percent to 2 percent in
addition to the annual cost of the deal. In other words, if
you're sending $10 million worth of work to India, selecting
a vendor could cost you anywhere from $20,000 to $200,000
each year”.
• “Some companies hire an outsourcing adviser for about the
same cost as doing it themselves. To top it off, the entire
process can take from six months to a year, depending on the
nature of the relationship”.
• “Bottom line: Expect to spend an additional 1 percent to 10
percent on vendor selection and initial travel costs”.
•
Source: The Hidden Costs of Offshore Outsourcing. Sep. 1, 2003 Issue of CIO Magazine
MIT5312: Professor Kirs
Slide 19
Outsourcing
Some arguments for NOT outsourcing
• Hidden Costs:
• The Cost of Transition
• “The transition period is perhaps the most expensive stage of
an offshore endeavor. It takes from three months to a full
year to completely hand the work over to an offshore
partner. If company executives aren't aware that there will be
no savings—but rather significant expenses—during this
period, they are in for a nasty surprise.”.
• “It took an awful lot of time to bridge the Pacific and getting
that to work correctly," remembers Textron Financial's
Raspallo, who spent six months and $100,000 to set up a
transoceanic data line with Infosys in 1998, It also cost an
extra $10,000 a month to keep that network functional.”.
• Bottom Line: Expect to spend an additional 2 percent to 3
percent on transition costs”.
MIT5312: Professor Kirs
Slide 20
Outsourcing
Some arguments for NOT outsourcing
• Hidden Costs:
• The Cost of Layoffs
• “To begin with, you have to pay workers severance and
retention bonuses. You need to keep employees there long
enough to share their knowledge with their Indian
replacements. People think if they give generous retention
bonuses it will destroy the business proposition. They cut
corners because they want quick payback. But then they lose
the people that can help with the transition and incur the
even bigger cost of not doing the transition right.".”.
• Bottom line: Expect to pay an extra 3 percent to 5 percent on
layoffs and related costs.
MIT5312: Professor Kirs
Slide 21
Outsourcing
Some arguments for NOT outsourcing
• Hidden Costs:
• The Cultural Cost
• “You simply cannot take a person sitting here in America
and replace them with one offshore worker," GE Real
Estate's Zupnick says. "Whether they're in India or Ireland
or Israel”
• “a project that's common sense for a U.S. worker—like
creating an automation system for consumer credit cards—
may be a foreign concept offshore.”
• Bottom line: Expect to spend an extra 3 percent to 27
percent on productivity lags.
MIT5312: Professor Kirs
Slide 22
Outsourcing
Some arguments for NOT outsourcing
• Hidden Costs:
• The Cost of Ramping Up
• "If you're an organization that develops and maintains by the
seat of your pants, or it's a case where Mary Jo and Fred have
been here for 30 years and they know how to do everything,
you are in trouble"
• “If a company doesn't create solid in-house processes, the
vendor will have to put more people onsite to compensate for
your inadequacies, and they'll spend all of your savings," says
Meta Group's Davison.
• “When you have to package specs to go outside the company,
that has to be done exceptionally well and that is timeconsuming and costly”
• Bottom line: Expect to spend an extra 1 percent to 10
percent on improving software development processes.
MIT5312: Professor Kirs
Slide 23
Outsourcing
Some arguments for NOT outsourcing
• Hidden Costs:
• The Cost of Managing an Offshore Contract
• "There's a significant amount of work in invoicing, in
auditing, in ensuring cost centers are charged correctly, in
making sure time is properly recorded," explains DHL's Kifer.
"We have as many as 100 projects a year, all with an offshore
component, so you can imagine the number of invoices and
time sheets that have to be audited on any given day."
• We knew there would be invoicing and auditing," he says.
"But we didn't fully appreciate the due diligence and time it
would require."
• Bottom line: Expect to pay an additional 6 percent to 10
percent on managing your offshore contract
MIT5312: Professor Kirs
Outsourcing
Some arguments for NOT outsourcing
We aren’t going any
further until the
class comes up
with at least three
other reasons why
outsourcing is a
BAD idea.
Slide 24
MIT5312: Professor Kirs
Slide 25
Outsourcing
Organization-specific considerations in Outsourcing
• Development Portfolios
•
•
Number
Structure
Attractiveness
Attractiveness
• Organizational Learning
•
Experience in assigning responsibility
Attractiveness
• IT Currency
•
Currency
Attractiveness
• IT Organization
•
Segregation
Attractiveness
MIT5312: Professor Kirs
Slide 26
Outsourcing
Structuring the Outsourcing Alliance
• Contract Flexibility
• 8-10 Years
• Frequent Renegotiation necessary due to:
• Technology changes
• Changing business/economic conditions
• Emerging competitive services
• Performance Standards for System response
time, availability of service, responsiveness
• Controls
• Safeguards against disruption of operations support
MIT5312: Professor Kirs
Slide 27
Outsourcing
Structuring the Outsourcing Alliance (Cont.)
• Partial Outsourcing
• Can the outsourced area be readily separated from
the rest of the firm?
• Does the outsourced area require expertise not
possessed by the firm?
• Realistic determination of Cost Savings
•
•
•
•
IT departments will view outsourcing as a threat
Outsourcing Consultants tend to skew outcomes
Senior Management Involvement necessary
Post implementation audits a must
MIT5312: Professor Kirs
Slide 28
Outsourcing
Structuring the Outsourcing Alliance (Cont.)
• Supplier Stability and Quality
• Need to examine supplier’s financial structure
• Note: Insourcing is a more difficult than outsourcing
• Management Fit
• Similarity in Corporate Cultures
• Conversion Problems
• Expertise/Information gained by Outsourcer
• Resolution of Internal Staff hiring/Lay-offs
• Career paths/job security
MIT5312: Professor Kirs
Slide 29
Outsourcing
Managing the Outsourcing Alliance
• A Strong CIO should be retained
• CIO responsibilities:
• Partnership/Contract management
• Long-term vision of architecture/interconnectivity
• Assimilation of emerging technologies/
discontinuation of obsolete applications/technologies
• Establishment of continuous internal learning/
training programs
• Establishment of realistic performance
Measures
• Must include intangible measures
MIT5312: Professor Kirs
Slide 30
Outsourcing
Managing the Outsourcing Alliance (Cont.)
• Mix and Coordination of In-house/
Outsourced Tasks
• Customer/outsourcer Interfaces
• Outsourcing may imply delegation of final authority
to the outsourcer
• Internal Coordination necessary
MIT5312: Professor Kirs
Slide 31
Outsourcing
A General Strategy
• Strategic Alignment:
• Instead of the traditional hierarchical organization, world-class
organizations understand that "flatter" management structures are more
effective. For example, an IT leader who interacts with other business
leaders as an equal is more likely to be tuned into their needs and to
the overall business strategy. Hackett's research shows that world-class
CIOs are twice as likely to report directly to the CEO or chairman as
CIOs at typical companies.
• Aligning IT with the business is crucial to success, yet IT is too often
seen as a "support" service and is not included in high-level decisionmaking. Having a "seat at the table" is essential to improved
performance. At 77 percent of world-class organizations, the senior IT
executive is a member of the company's primary management
committee, compared to just 52 percent of typical companies.
•
Source: Performance Gap Seen Widening in the Back Offices of Large Global Corporations
http://www.sdcexec.com/online/article.jsp?id=8962&siteSection=13
MIT5312: Professor Kirs
Slide 32
Outsourcing
A General Strategy
• Complexity Reduction:
• While words like "streamlining" and "standardization" have
become overused terms, world-class organizations achieve
tangible benefits by abolishing unnecessary complexity in
business processes. For example, world-class procurement
organizations reduce complexity through strategic sourcing,
consolidating their purchases among 78 percent fewer suppliers
than typical companies. They also centralize processes; Hackett
found that a typical company with $1 billion in annual spend can
save $8 million in process costs alone by increasing the
percentage of contracts negotiated centrally from 20 percent to
80 percent.
MIT5312: Professor Kirs
Slide 33
Outsourcing
A General Strategy
• Technology Enablement:
• Companies with world-class IT organizations now spend significantly
more on IT — 7 percent more per end user — than their peers, making
IT the only area studied by Hackett where world-class companies spend
more than typical ones. While world-class organizations spend more on
IT, their use of technology results in improved performance across other
SG&A areas. Hackett's research found that of the companies that
achieved world-class status in multiple functions, IT was one of those
functions 86 percent of the time — suggesting that cross-functional
excellence relies on world-class IT performance.
• Examples of the value of IT abound in Hackett's research. In part by
using technology to streamline and automate operations, world-class
organizations spend 45 percent less than typical companies on finance
operations, while at the same time generating tens of millions of dollars
in savings by getting clients to pay their bills 28 percent
MIT5312: Professor Kirs
Slide 34
Outsourcing
A General Strategy
• Business Process Sourcing:
• Understanding how to effectively leverage business process sourcing
options such as outsourcing, shared services and offshoring is a
hallmark of a world-class company. They do this at the process level
and do not hesitate to change sourcing solutions if they fail to produce
the desired result. Most executives miss the potential impact of service
globalization due to "under-scoping" of initiatives, not realizing that
offshore resources have matured significantly in the last few years.
• A good example of this is in IT. World-class IT organizations spend 17
percent more on outsourcing technology infrastructure than typical
organizations, but this enables them to spend 20 percent less in IT
labor, resulting in 8 percent lower overall technology infrastructure
process costs.
MIT5312: Professor Kirs
Slide 35
Outsourcing
A General Strategy
• Cross-Functional Partnering:
• World-class organizations seek synergies across business functions
through cross-functional cooperation to achieve common goals. For
instance, procurement staff work alongside their functional peers to
understand business needs, plan spending and supplier selection (at
the best price), taking into account both current and future needs.
World-class procurement organizations are more than three times as
likely as typical companies to rely on cross-functional teaming for
supplier development. World-class HR managers are up to four times
as likely as their peers to partner with management in key areas such
as developing business strategies.
MIT5312: Professor Kirs
Outsourcing
Slide 36