Are Outsourcing Cost-Savings Estimates Misleading?

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META Group is now warning of a substantial political risk for executives who assume that their companies will achieve a 40% savings by outsourcing IT services and development. Such savings are not real, says META. In fact, the savings are more likely to be in the 15-20% bracket.

This misleading presumption by many IT executives is based upon the idea that a company can replace, one for one, the efficiencies of an in-house programmer or stateside consultant with a less-expensive outsourcing developer and then pocket the difference. For instance, the cost of a full-time equivalent programmer in India is 60% of the cost of a stateside equivalent.

Factors That Drive Up Costs

However, according to META, there are a number of factors that will drive up costs, impact security, and create requirements that must be absorbed by the corporation.

"A common oversight for IT organizations is a contingency plan--what happens if the vendor, all best intentions and contracts aside, simply fails to deliver. Though this scenario may be unlikely, the IT organization must assess the implications of vendor failure," says Dean Davison, META Group vice president. "High risk or exposure might deter the organization from outsourcing, it might shift the outsourcing strategy, or it might drive the company toward outsourcing. The results of risk analysis vary among companies; it is the process of risk analysis that is paramount."

There are a number of other factors that companies must consider in outsourcing development or projects:

  • Security--The risk of security breaches or loss of intellectual property protection is inherently raised when working in international business. Privacy concerns must be addressed.
  • Scope Creep--According to META, there is no such thing as a "fixed-price contract." Most outsourcing projects change by up to 15% during the development cycle.
  • Culture--Many leading outsourcing vendors have cultural education programs, but executives should not assume that cultural alignment will be insignificant or trivial.
  • Knowledge Transfer--The time and effort to transfer knowledge to the vendor is a cost rarely accounted for by the IT organization, according to META. They observe that IT organizations experiencing a 20% decline in productivity during the first year of an agreement, largely due to time spent transferring technical and business knowledge to the vendor.

Outsourcing Will Still Grow in Importance

Despite these obstacles, META estimates that outsourcing, as an industry, will grow 20-25 % over the next two years, and the largest part of that sector will probably be headed overseas to developing countries where personnel costs are lowest.

This is a somber prediction for developers here in the states, where the IT recession that started in 2000 continues to eat away at technology jobs and consulting portfolios. According to Matthew Slaughter, associate professor of business administration at Dartmouth College, the movement toward outsourcing IT jobs will progress at a much faster rate than for jobs in other sectors, such as manufacturing. "[IT work] will move faster because it's easier to ship work across phone lines and put consultants on airplanes than it is to ship bulky raw materials across borders and build factories and deal with tariffs and transportation." By the end of 2004, Gartner Group estimates, one in 10 IT jobs at U.S. IT companies and one in 20 at non-IT companies will move offshore.

Outsourcing as a Trend in Political Posturing

It's not surprising, then, that outsourcing has become one of the hottest political issues facing candidates in the upcoming presidential election. All of the major Democratic candidates have a position on the economic cost to U.S. jobs when companies outsource, and indeed, the debate about outsourcing generally is not an IT-specific issue. Meanwhile, diverse stories about corruption in outsourcing continue to fill the news: the assignment by the U.S. government of outsourcing contracts to rebuild Iraq; the outsourcing contracts with undocumented workers to provide Wal-Mart janitorial services. The common thread to all of these stories is that organizations do not want to shoulder the expense of providing jobs for services that are outside their "core competencies."

Value-Add IT

The main question remains: If outsourcing is to become a key element of doing business in a global economy, how can IT sustain its standing within an organization? What is the "value-add" that IT provides within an organization?

The technological advances made within IT during the late 1990s continually fragmented the overall business knowledge that IT professionals were employing in their jobs: Packaged systems, object-oriented programming technologies, and a focus upon "technical skills" rather than project management and corporate business goals have divested many IT managers of the values that once made a strategic difference to their organizations. At one time, an IT organization was a reflection of the business culture that drove the organization. Today, IT is often a reflection of the corporations that created the business software and hardware packages that run the client organizations.

And, unfortunately, when IT thinks strategically today, it is thinking of technological advances in the IT industry; it would be hard-pressed to pinpoint how those advances can be manifested in the corporations that actually employ them. Indeed, IT's knowledge has become compartmentalized and wholly technical, while the business challenges faced by their parent companies are of a different category entirely--global in scope, competitive to the bottom line, and accountable to fluctuations of the stock market.

Is it any wonder then that, when faced with the prospect of saving money by outsourcing IT development, CFOs quickly latch onto this potential? When was the last time IT really contributed to the bottom line?

IBM's On Demand Strategies Feed the Trend

Last, but not least, IBM's own On Demand strategies within the IT industry continue to stress the need for organizations to focus upon their core competencies, shoving non-core services out to the global marketplace.

In nearly every area where IT has traditionally interfaced with IBM products in the past, the IBM Corporation has positioned its Global Services Division to compete directly with internal IT services to complement or replace their functionality. In fact, most outsourcing organizations are modeling themselves after the success of IBM Global Services, going over the heads of IT directly to the financial controllers of larger corporations and offering them opportunities that are difficult to resist. Little heed to the long-term viability of those services, in relation to the overall strategic goals of the company, is given. Often such services are presented simply as "cost-containment" strategies that CFOs leverage into wholesale outsourcing projects. Like the nose of the camel under the tent, once companies begin divesting themselves of their IT expertise, it's difficult to stop the process.

META Group's Warnings

META Group's warnings against those proclaimed cost-savings may offer a bit of relief to besieged IT organizations. Instead of focusing merely upon cost savings, META is revealing the hidden cost factors inherent in any outsourcing endeavor.

And if IT is really to become an On Demand outsourced service, as pundits are predicting, then corporations will soon be faced with a new set of challenges: how to reclaim their technical preeminence within IT to sustain their core competencies once they've lost their technical and business skills to service organizations. The trend toward outsourcing will reverse when companies again realize that innovation within their own industry is based upon both business savvy and technical talent.

Thomas M. Stockwell is Editor in Chief of MC Press, LP.