The Rewards of Right-Sourcing: Why IT Sourcing Matters to CEOs and Boards

IT outsourcing deals are some of the largest financial commitments companies make, totaling as much as $5 billion. What’s more, they often encompassed a company’s “crown jewels”—those mission-critical proprietary systems that provide a competitive advantage.

Recently, however, companies are insourcing that which was once outsourced. Why does one CEO outsource while another insources? What should CEOs consider when weighing their options?

THE DRIVE TO OUTSOURCE
While there are many reasons companies opt to outsource and send work offshore, cost-cutting typically tops the list of drivers. The promise of 20 to 25 percent savings to the bottom line is a powerful driver. Outsourcing can shift fixed costs to variable or, better yet, enable contracts can be “financially engineered” to pull savings ahead, creating a windfall for current management.

Outsourcing can also enable a company to quickly acquire new technical capability and capacity to expand, move into new markets or overcome internal inertia. Outsourcing also becomes attractive when IT issues consume unreasonable amounts of management time and attention. However, there are pitfalls of which you should be aware.

PROBLEMS AND PITFALLS
An outsourcing contract defines your flexibility. How well or poorly the contract is written determines how nimble you can be. Many years ago, in the Ross Perot days, GM outsourced its IT. Recently, GM’s current CIO, Randy Mott, famously said, “When we have an urgent need for IT changes, I don’t call the programmers, I call the lawyers.”

When systems provide a competitive advantage, this inflexibility becomes particularly problematic. The need for speed and control is one reason we’ve seen CEOs move to in-source. For example, JP Morgan canceled its $5 billion IT outsourcing deal with IBM and brought everything in house in 2004, as did Bank One a few years earlier. Anticipated savings often go unrealized
because contracts are badly written, poorly defining current and future situations. Frequently, business changes are not anticipated and vendors charge extra for each change.

In addition, the skills necessary for maintaining and enhancing the systems are often underestimated. During a recent network outage, the CEO of a high-volume financial payment processor
asked why the company’s technical expert was so slow to respond. “He was terminated last week as part of our outsourcing deal,” he was informed. Furthermore, management sometimes squeezes vendors during negotiations. To break even, the vendor responds by strictly following contract language and performs the bare minimum, resulting in poor service.

Outsourcing and offshoring can also provoke social unrest within the company. Organization structure and jobs change and people get laid off. While this may be intentional to jog the organization into a new operating paradigm, it invariably results in mistrust, passive-aggressive behavior and a dip in loyalty and productivity.

Finally, IT outsourcing is often a one-way street with supplier lock-in. During the transition, the vendor capitalizes on the talent and spreads it across multiple clients. Once lost, this technical expertise is difficult to re-acquire. Those folks are now gone and one has the challenge to find and train new talent to support the old custom systems.

CEO RESPONSIBILITY
For these reasons, CEOs and boards must carefully assess the rationale and consequences of both outsourcing and insourcing IT and be sure to craft a good contract. The benefits can look
great particularly in the short run—but the pitfalls can cause significant damage later in the game.

Because the vendor has crafted hundreds of these deals, they are experts at contract negotiation and have the upper hand. Your goals and theirs are different—you seek responsive, low-cost service. They seek profits. So, before you jump, it may be prudent to seek the advice of an experienced and independent advisor who is 100 percent focused on your goals.