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The Virtues of Virtual

Internet connectivity continues to bring forth options for outsourcing.
Lauren Gibbons Paul, CFO Magazine
August 1, 2001

At Ryder System Inc., human capital is precious. So when the $5 billion Miami-based logistics and transportation giant decided to overhaul its credit-approval process in 1999, it knew the solution could not entail a large boost in head count or add to the workload of current employees.

Fortunately, a new outsourcing option had just emerged. A fledgling firm in Dedham, Massachusetts, called eCredit.com, offered a service it dubbed the Global Financing Network.

For an initial fee and then a monthly charge, Ryder is able to rely on this application service provider (ASP) for a service that allows it to instantly assess a potential customer's credit history and respond with a price and interest rate finely tuned to the customer's creditworthiness. All transaction histories and other data are maintained by eCredit.com on its own systems, while software installed at Ryder allows the company to access the Global Financing Network to get real-time credit assessments on potential customers.

Driven by the capabilities of the Internet, much of what was once labeled outsourcing might be better dubbed "E-sourcing." With cycle times shorter than ever, capital scarce, and skilled workers hard to find and retain, companies are looking more closely at all forms of outsourcing. Vendors are responding with a host of new options.

The long-term, wholesale outsourcing of the IT function (called "dino-sourcing" by some) is now complemented by a wide range of other options, and customers are taking notice. The annual growth in the ASP market, which is the dominant form of E-sourcing (but not the only form; see below) is pegged at 54 percent, according to research firm Gartner, compared with approximately 15 percent for traditional outsourcing.

More important than the growth, perhaps, are the new types of services that E-sourcing makes possible. At Ryder, senior executive vice president and CFO Corliss "Corky" Nelson says the firm's new approach to credit approval provides maximum flexibility and a near-instant redeployment of internal resources. "eCredit gives us a way to use our thin human capital more wisely," he says.

Credit processors can now focus on higher-value activities, such as developing problem accounts. And Nelson expects the eCredit.com investment to pay for itself within three years. "That was another big selling point," he says.

In addition to the aforementioned ASP model, companies can acquire infrastructure or "managed" services through MSPs, security services through SSPs, commerce services through CSPs, and so forth, all of which have come to be lumped under the term "XSP." But E-sourcing goes further than that; established outsourcing giants such as Accenture (formerly Arthur Andersen's IT consulting arm) have teamed with such companies as Jamcracker Inc., which aggregate a range of E-source options and provide something like one-stop shopping for clients.

Early this year, IBM rolled out IBMPlaces, a Web-based service that rents applications tailored to the needs of automakers and their suppliers. The applications come from IBM and other vendors, and can be bundled and sold at a compelling price. The Digital Engineering Office option, for example, combines five applications and costs $90 per user per month.

Competition among these providers is fierce, and some have succumbed already, making potential customers nervous about the long-term viability of this model. But at the same time, current economic conditions make outsourcing of any kind more appealing. Internal technology projects that would have received a fast green light last year are hanging up on the shoals of close financial analysis.

"When money was a little looser, there was not as much pressure to do rigorous cost-benefit analyses — even from CFOs," says Chip Gliedman, a research fellow at Giga Information Group Inc., in Cambridge, Massachusetts. "Right now, every dollar spent is coming under increasing scrutiny." Gliedman says that E-sourcing deals often stand up to close inspection.

"No Comparison"
When employee benefits firm RewardsPlus Corp. decided to expand the scope of its offerings last year, the Baltimore-based company might have been expected to handle the task in-house. After all, it had been delivering insurance and other services via the Internet for five years.

But then RewardsPlus decided to offer shopping services so that employees at client companies could order flowers, buy gifts, and in general improve their work/life balance by tapping the power of the company Web site. The firm quickly realized that it could not aggregate retail shopping items as easily as it had tackled financial services products, such as insurance. Jamie Spriggs, the company's CIO, calculated that such a system, which would function essentially as an online mini-mall, would cost about $3 million to build and $1 million a year to maintain, far outstripping the company's infrastructure and resources.

Spriggs and his team evaluated a number of shopping content aggregators and eventually chose Scottsdale, Arizona-based Vcommerce Corp. The economics of the deal were compelling: Vcommerce's fee for building, hosting, and supporting the online store was less than 3 percent of what Spriggs had determined a homegrown system to be.

He might have spent even less: Many commerce providers offered free installation, with fees based on a percentage of transactions that took place on the site. Spriggs questioned the financial viability of this approach, and was proven right. Many of the companies making such offers have since gone out of business, and the survivors have readjusted their offers, focusing on profitability rather than acquiring customers at any cost.


What's notable about the deal is that it provides RewardsPlus not with some form of internal functionality it had to have, but with an additional offering it can take to the market. Spriggs hopes to sell clients on the value of increased employee satisfaction.

He cites an internal Sears, Roebuck and Co. study that found that a 5 percent increase in employee satisfaction translated into a half- percent increase in revenues. "Employees who are happy with their benefits demonstrate a much greater commitment to the company," he says. While the ability to shop on company time may seem like a curious addition to the usual retinue of employee perks, the fact that RewardsPlus can offer that capability so cheaply, thanks to its outsourcing arrangement, means that payback does not hinge on wide acceptance.

According to Margaret Johnsson, president of The Johnsson Group, a Chicago-based finance and accounting consultancy, the payback from E-sourcing must be assessed not only in financial terms, but from a broader, more-qualitative perspective as well. She cites as one example a large health-care company that wanted to expand its stock-option program from senior management to its entire 10,000-person global workforce.

The program had been managed by two full-time employees, but it immediately became clear that they wouldn't be able to handle a vastly expanded program, one that called for a transaction-based Web site so that employees could manage their accounts at any time.

The outsourcing of the entire project to a major financial services firm allows employees to buy or sell options instantly. (In the past, transactions took two weeks to execute.). In addition, errors have been reduced because the system is integrated with the company's internal HR applications. Staffers who had once shuffled papers are free to help employees with more complicated stock option problems, and the outsourcer takes care of international compliance and reporting issues for the foreign markets in which the company operates.

There are many challenges to making such deals work, including choosing the right partner, coping with often bumpy transition periods, establishing and monitoring appropriate service levels, and deciding what to do with any staff members who might be rendered obsolete. It can also be difficult to gauge the value of capabilities that E-sourcing makes possible.

Case in point: outsourcing intrusion detection on a corporate network. "Intrusion detection is one of the most critical issues a company can address. But it's more like cost avoidance than return on investment," says Jeff Dow, vice president of information security at News Corp., a $14 billion media company in Los Angeles.

After all, it's difficult to put a price tag on a network attack that doesn't happen. News Corp. outsources this facet of computer security to Vigilinx Inc., in New York, a company that relies on real-time and post event analysis of all network traffic to detect and react to suspicious activity. Dow says he didn't have to think too hard about the value proposition.

"We would need to hire people who had a lot of security experience — people who would cost at least $100,000 per year," he explains. Throw in overhead, and consider that with more than 50,000 employees Dow figured he would need a team of 10 to 12 of these expensive professionals, and the appeal of E-sourcing becomes immediately apparent.

Outsourcing network security was largely impossible prior to the coming of the Internet, says Michael Assante, vice president of intelligence at Vigilinx. With traditional outsourcing, you would have to be on- site to manage network security of the network, and it would be just as easy for customers to build their own departments. With the Internet, we have the ability to leverage substantial expertise from a central location — at a reasonable price.

Alex Thomson, director of technology for Houston Harbaugh PC, a Pittsburgh law firm that advises small to midsize businesses on outsourcing, says that because so many companies in this space are new (Vigilinx, for example, was formed earlier this year), due diligence should be a top priority for would-be clients.

He recommends running a Dun & Bradstreet inquiry on the company, asking to see its financials, and scrutinizing its income statement, balance sheet, and capitalization structure. "It's so easy to start an ASP today," says Thomson, "but that doesn't mean it's a good company that will be around." Always ask for customer references, and don't settle for two or three.

"If an outsourcer can readily fork over 10 customer references, that means something," says Laurie McCabe, vice president at Summit Strategies Inc., a Boston market strategy and consulting firm. "If they can give you only one, that may mean something else."

News Corp.'s Dow agrees that due diligence is critical. "I investigated how much funding they had received and what their balance sheet says. I didn't want to go with a company that was $20 million in debt."

Although he has confidence in Vigilinx, Dow made sure the contractual terms allow him to walk away easily. While making the transition from a conventional outsourcing arrangement can be a thorny process, with E-sourcing it's another matter entirely. As Dow says, "It would take less than two minutes to disconnect them from our network."




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