Issues In Global Outsourcing

THE CHANGING LANDSCAPE OF GLOBAL INFORMATION TECHNOLOGY

Background on IT Outsourcing: Companies are increasingly turning to global outsourcing for Information Technology ( $IT$ ) due to concerns regarding cost, quality, lagging performance, supplier pressure, and various financial factors.
Core Contention: F. Warren McFarlan argues that while the detailed execution of $IT$ tasks can be outsourced, the fundamental management responsibility cannot. Consequently, the role of the Chief Information Officer ( $CIO$ ) will become more critical in the next decade, shifting from managing large internal staffs to managing complex networks of external relationships.
Key Technological and Economic Drivers: Several dramatic changes since the early $1990s$ have reshaped global $IT$ management: * Hardware Economics: A sustained $35-50\,\%$ annual drop in the cost of chips, memory, and hardware has fundamentally altered the economics of global information services. * Communications Infrastructure: The explosion of affordable broadband fiber optic cables across $6$ continents, supplemented by satellite communications, has enabled seamless connectivity. * Inter-Organizational Systems: The surge in systems that link organizations, accelerated by the prominence of the Internet, has increased global interconnectivity. * External Software Reliance: The reality for modern firms is that less than $0.1\,\%$ of the code used internally is developed in-house. Information systems organizations have transitioned into internal systems integrators. * Global Case Studies: Major firms such as Xerox and Kodak have legitimized the practice by outsourcing significant portions of their international operations.

THE EVOLUTION OF TECHNOLOGY AND OUTSOURCING TRENDS

Future Outlook: Technological evolution and cost-performance improvements are expected to continue at current or accelerated rates for the next $20$ to $30\,\text{years}$ . This creates a constant need for firms to scan alternatives and manage the risk of software implementation versus the risk of becoming technologically backward.
Global Information Highways: Global networks are evolving similarly to the $19th\,\text{century}$ railroads or $20th\,\text{century}$ highways, which typically took $50$ to $70\,\text{years}$ to stabilize and ultimately reshaped society in unforeseen ways.
Market Growth: Outsourcing is a massive growth industry because firms often lack the capital or internal expertise to develop proprietary solutions. Last year alone ( $1994$ ), over $\$40\,\text{billion}$ in outsourcing contracts were written.
Historical Analogy: In the $1880s$ , most companies generated their own electricity; by $1910$ , they utilized large public utilities. The $IT$ services industry is undergoing a similar transition as it enters the $21st\,\text{century}$ .

ISSUES IN SOFTWARE DEVELOPMENT OUTSOURCING

Existing Industry Standards: Most firms already outsource standard software, such as operating systems, word processing, $CAD$ , and $LAN$ software, to specialist firms located near innovative talent pools.
In-House Software Roles: Organizations still develop in-house software to link packages to specific needs or to execute massive customized projects where packages do not exist (e.g., a $\$25\,\text{million}$ order entry system or a $\$30\,\text{million}$ inventory management system).
Project Characteristics Influencing Outsourcing Success: * Project Size: Larger projects (in terms of dollars, staff, and time) have more appeal for outsourcing because coordination costs are more easily absorbed by a larger base. However, projects much larger than a firm's normal experience are highly risky. * Experience with Technology: Risk increases as the team's familiarity with hardware, databases, and languages decreases. Technically skilled outsourcers can mitigate these risks. * Project Structure: "Highly structured" projects (where outputs are fixed and defined from the start) are easier to outsource. Conversely, projects with evolving specifications or those requiring frequent management judgment, such as Business Process Reengineering ( $BPR$ ), are extremely difficult to outsource globally.
Case Failure Example: A chemical company's $BPR$ effort resulted in $700,000\,\text{lines of code}$ that were perfectly debugged but designed for a "non-existent real-world situation" because specifications evolved faster than development at a geographic distance.

INTERNATIONAL SOFTWARE OUTSOURCING DYNAMICS

Labor Cost Disparities (1995 Data): Cost differences legitimize international outsourcing. For example, a client/server programmer in India may cost $\$7,500$ , compared to $\$75,000$ or more in the eastern United States.
India as a Hub: By the start of $1995$ , over $100,000\,\text{people}$ in India were dedicated to developing software for $USA$ and Western European firms. Factors for success in India include English as a primary language, a strong educational system, and robust global communications.
Other Emerging Regions: Similar trends are appearing in the Philippines, with aggressive discussions taking place in China and the Russian Republic (though language barriers exist in the latter two).
Exhibit 1: Organizations Conducting Major Development in India: * Abbey National, Apple, Arthur Anderson, Anz Bank, Allied Vans, AT&T, Ashton-Tate, Britannia Building Society, British Telecom, Ciba-Geigy, Citibank, Consolidated Freightways, Data General, Digital, Dun and Bradstreet, Fireman's Fund Insurance, Hewlett Packard, IBM, John Deere, KPMG, Merrill Lynch, Microsoft, North West Water, Novell, Oracle Corp., Price Waterhouse, Singapore Airlines, Swiss Air, Texas Instruments, Unisys, Verifone, Woolwich Building Society.

MANAGEMENT IMPLICATIONS FOR GLOBAL SOFTWARE DEVELOPMENT

On-Site Assessment: Managers should visit the country and evaluate firms directly. Relying solely on firms with an expensive $USA/European$ marketing presence may miss potential savings, as these marketing costs increase project totals significantly.
Phased Integration: Firms should start with several modest projects to establish an appropriate global work pattern before undertaking "mega" development efforts.
Financial and Record Stability: Entry and exit barriers in the software industry are low; therefore, carefully checking client references and financial stability is mandatory.
Dual-Path Strategy: Outsourcing can be used for new client/server applications (allowing internal staff to maintain legacy code) or for legacy maintenance (freeing internal staff for future technologies).
Managing Internal Hostility: Transitioning knowledge work to global markets may cause internal friction similar to the offshoring of manufacturing. Managers must navigate this to avoid competitive disadvantages.

DRIVING FORCES FOR OPERATIONAL OUTSOURCING

Management Frustration: Frustration with $IT$ costs and response times is a primary driver, especially when legacy systems trap resources in a spending spiral.
Standardization and Cost Savings: Installing global infrastructure standards in-house is difficult. Average internal network costs of $\$10,000$ to $\$13,000$ per client per year can be reduced to $\$4,000$ to $\$5,000$ through outsourcing.
Focus on Core Competencies: Firms simplify their management agenda by delegating data center and network operations to specialist vendors like $IBM$ , Andersen Consulting, Computer Sciences Corporation, and $EDS$ .
Financial Benefits: Outsourcing allows firms to take assets off the balance sheet (the outsourcer often buys equipment at book value plus a premium) and convert fixed costs into variable costs.
Cultural Change and Clout: Third-party contracts provide the professional "clout" needed to enforce standards or collapse redundant data centers where internal $IT$ departments might lack the political influence.

RISKS IN GLOBAL OPERATIONAL OUTSOURCING

Loss of Control: A common fear that managers lose control over resources. McFarlan argues that firms already depend on external utilities (water, power, telephone) and that $IT$ is a similar evolving interdependence.
Lack of Scale Gains for Efficient Firms: Large or highly efficient organizations should conduct pragmatic disinterested analysis; a profit-seeking outsourcer may not offer savings to a firm that is already optimized.
Vendor Stability and Duration: Operational contracts are typically $8$ to $10\,\text{years}$ in duration due to economic structures. Total satisfaction with the partner's long-term financial viability is required.
Regulatory Gaps: Unlike power or telephone companies, there was no regulatory supervision for outsourcers in $1995$ . McFarlan predicts regulations will eventually arrive.

THE STRATEGIC GRID FOR INFORMATION RESOURCE MANAGEMENT

McFarlan utilizes a grid based on Current Dependence on Information and Importance of New System Development to assess outsourcing presumptions:

Support Quadrant (Low Dependency / Low Importance): * Presumption: YES. * Reasons: Access to higher professionalism, reduced risk of inappropriate architectures, and access to current technologies.
Factory Quadrant (High Dependency / Low Importance): * Presumption: YES (unless the company is huge and exceptionally well-managed). * Reasons: Economies of scale for small/midsize firms ( < \$500\,\text{million} sales), higher quality service, and facilitated management focus.
Turnaround Quadrant (Low Dependency / High Importance): * Presumption: NO. * Issues: Complexity of negotiating long-term contracts when the operations function is being radically transformed (e.g., shifting to client-server).
Strategic Quadrant (High Dependency / High Importance): * Presumption: NO. * Reasons: IT is a core differentiating competence that should be part of the firm's skill portfolio, unless there is a crisis of competence.

EXHIBIT 3: CASE STUDY ON XEROX CORPORATION

Reasons for Xerox Outsourcing Its Global IT Activities: 1. Accelerating data center consolidation faster than internal staff could accomplish. 2. Gaining access to more specialized vendor knowledge. 3. Leveraging vendors' economies of scale and purchase discounts. 4. Enabling easier enforcement of global standards. 5. Relieving management of custodial responsibility for old systems to focus on new development. 6. Faster phasing-down of Legacy systems. 7. Sharpening focus on the company mission as "The Document Company."

SUMMARY AND STRATEGIC CONCLUSIONS

Continuous Importance of Leadership: Global outsourcing does not eliminate the need for senior $IT$ leadership. The $CIO$ remains responsible for emerging technology pilot projects, long-term information architecture, and global database evolution.
Outsourcing as a Philosophy: Outsourcing is a mix-and-match philosophy rather than a single technique. For laggard firms that have failed to invest in $IT$ , it may be the only pragmatic way to catch up with competitors.
Measurement of Success: Since measuring internal potential vs. external results is difficult, success in global outsourcing remains hard to prove definitively, though many managers report they are comfortable with the results.