Costs, Benefits, and Risks

A dominant explanation for companies outsourcing IT is costs. In this chapter, we discuss production and transaction economics, hidden costs and contract termination costs, and we will also examine benefits and risk behavior.

Contract Development

According to Graham (2003), one of the games lawyers play in negotiation meetings relating to outsourcing is to bet how long it will be until one party describes the outsourcing as a “partnership.” Nothing could be farther from the truth: the parties’ interests overlap, but they are not congruent, and neither party will put its existence on the line for the other. A relevant approach in contract negotiations is to see the outsourcing as the creation of a long-term, flexible relationship, but one that exists within a framework of rules that support its success while addressing failures practically. The contract, therefore, has a sophisticated role not only as the passive record of the parties’ agreement, but also as the guidebook for the evolving transaction. This chapter considers the structure of the contractual documents and the key issues that need to be reflected in them. Elizur and Wensley (1998) apply game theory in their study of IS outsourcing contracts. They find six typical issues arising in an outsourcing situation: the transfer of IS assets, risk sharing, technology upgrading, contract duration, relationship management, and fee arrangements. In addition, we have added the important topics of due diligence and dispute resolution. We will consider each of these issues separately after our discussion of contract structure.

IT Outsourcing Theories

Based on outsourcing definitions explored in Chapter II, we can identify taxonomies, or schools of IT outsourcing. The primary purpose of this framework is to guide executives on choice to initiate outsourcing projects according to goals, organizational character, and technological, behavioral, or economic biases. This approach is adapted from Earl (2001).

Knowledge Management

In an outsourcing relationship, the vendor and its clients need to transfer knowledge on a continuous basis. Relevant approaches to outsourcing relationships from the knowledge management literature include intellectual capital management and business process management, as presented in this chapter. According to Quinn (1999), executives increasingly understand that outsourcing for short-term cost cutting does not yield nearly as much as outsourcing for longer-term knowledge-based system or strategic benefits such as greater intellectual depth and access, opportunity scanning, innovation, reliability, quality, value-added solutions, or worldwide outreach.

Governance Structures

The overall objective of this chapter is to concentrate on the important issues of strategy, structure, and management of IT outsourcing arrangements. Using well-known theoretical perspectives described earlier in this book and experience earned from several business case studies in this book, we present a governance model for successful management of IT outsourcing relationships.

Phases and Activities

Lacity and Willcocks (2000a) identified six outsourcing phases. In these phases, a variety of stakeholders are involved, such as customer senior business managers, customer senior IT managers, customer IT staff, IT users, supplier senior managers, supplier account managers, supplier IT staff, and subcontractors. Stakeholder relationships vary during activities within phases, depending on goal alignment. For each of the phases, Lacity and Willcocks (2000a) defined the major stakeholder goals, interactions, and outcomes witnessed in practice.

Some Fundamental Perspectives

In this chapter, we cover some topics that contribute to a broader understanding of the role of IT outsourcing. We start by presenting value configurations consisting of primary and secondary activities in order to understand the role of IS/IT in different value configurations such as value chains, value shops, and value networks. Next, we look at electronic business infrastructure, where the extent of IT outsourcing can be determined by choosing from a list of 70 infrastructure services. E-business has a double role here, as an outsourced IT function more and more will be handled electronically. This means that the transactions between vendor and client after outsourcing will be conducted as electronic business. Third, we present a vendor value proposition that explains why a vendor may create value for the client because of its complementary competencies. Then, we look at IT function organization, outsourcing performance, and successful relationships. We conclude this chapter by discussing opportunities and threats in IT outsourcing.

Personnel Issues

Many of the potential problems with outsourcing can be avoided by carefully deciding which IT services can appropriately be contracted out and which cannot. Other problems, however, can only be avoided by an effective implementation of that decision and one such is the potential staff problem when transferring IT management and operation to an external body. Staff, however, often find the growth potential, greater variety, and greater business focus of some outsourcing jobs very appealing, and working for an outsourcing vendor is actually popular with some staff once the transition has been made. To an IT staff person, the vendor organization can offer wide and interesting career paths and almost a return to the traditionally sized IT section with all its scope for specialism. This variety of career path is unlikely to be offered by the slimmed-down IT provision internal to most organizations. The vendor’s core business is IT and hence resources flow into new developments and advances in a way that can give interesting and rewarding career opportunities. Instead of IT staff being treated as a necessary overhead, they become the organization’s critical asset. Not all outsourcing jobs are equally appealing, however, and some roles can be very unpopular (Robson, 1997).

Exit Strategy

Outsourcing contracts do not last forever. And sooner or later, the client has to think of “where to go by the end of this contract?” and “how to get there?” Resources are necessary no matter if the decision is renegotiating with current supplier, changing supplier, or bringing IT home. Sometimes, unexpected events occur, and these needs require resources as well.

IT Outsourcing

Given the potential headaches of managing IT, it is tempting to hand the job over to someone else. Indeed, outsourcing once appeared to be a simple solution to management frustrations, and senior management teams at many companies negotiated contracts with large service providers to run their entire IT functions. At a minimum, these providers were often able to provide IT capabilities for a lower cost and with fewer hassles than the companies had been able to themselves. But many of these outsourcing arrangements resulted in dissatisfaction, particularly as a company’s business needs changed. Service providers, with their standard offerings and detailed contracts, provided IT capabilities that were not flexible enough to meet changing requirements, and they often seemed slow to respond to problems. Furthermore, a relationship with a supplier often required substantial investments of money and time, which entrenched that supplier in the company’s strategic planning and business processes. The company then became particularly vulnerable if the supplier failed to meet its contractual obligations (Ross & Weill, 2002).