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Outsourcing IT can provide real benefits -- if you avoid traps like reduced access to key data, vendor inflexibility toward changing business needs, poor communications, internal resistance, and outsourcer price wars that undermine service.
Adam Lincoln, CFO Asia
February 1, 2001
On March 27 last year, hundreds of IT experts and administrators logged on to their computers as employees of Japan's Sumitomo Metal Industries, or SMI, one of the world's top producers of steel products. By the time they logged off at the end of the week, they were no longer working for SMI.
They hadn't been downsized — their bosses had merely signed a $660 million outsourcing deal that would "drastically reform" SMI's approach to information technology. As a result, the workers suddenly had a new master with another well-known name, IBM, the world's biggest computer company.
More precisely, their new employer was IS Information System, a Tokyo-based joint venture set up to manage the contract. IBM provided 65 percent of the outfit's start-up capital of $280,000 while SMI chipped in the rest. In a bold leap of faith, the Japanese company handed responsibility for SMI's information technology to IBM for the next decade. It also handed over a huge chunk of its staff. Most of the new company's 420-strong workforce arrived straight from SMI, while Hitoshi Yamaoka, a senior executive from IBM Japan, took over the helm.
As those SMI employees abruptly discovered, IT outsourcing is taking root in companies around the globe. Dataquest, a division of US-based research company Gartner Group, reckons global demand for outsourcing services will grow from $65 billion in 1998 to nearly $142 billion by 2003. Asian companies are moving more slowly than those in the US and Europe; most estimates put the region's slice of the global pie at about 10 percent, give or take a couple of percentage points.
But recent developments have spurred the regional market into action. Pressure for business reform, accelerating technology life-cycles, and a new reliance on the Internet have made IT a tough challenge for the typical in-house department. Whether they like it or not, Asia's companies are accepting a new home truth: There's no shame in turning to others for help.
No shame — and potential for significant rewards. According to the US-based authors of the Hatchett Benchmark 2000 report, selective outsourcing can lead to an IT saving of between 20 and 50 percent.
Certainly, there is no shortage of options. The outsourcing industry cut its teeth on mainframe data center services years ago. Today, there is practically no area of IT that can't be outsourced, from data centers to network management, from application support to proprietary software development, from help desks to PC installation and support. More recently, application delivery has entered the fray with the arrival of application service providers, commonly known as ASPs.
And while many companies will call on multiple vendors to supply services in specialty areas, others will place their eggs in one basket. "We believe in one-stop shopping," says Peter Goodwin, CFO of Collex, an Australian waste management services company with more than 60,000 clients. "That's the concept that we sell our customers, and that outsourcing logic works just as well for us."
A member of French conglomerate Vivendi, with more than 2,400 employees — including just 16 at the head office in Sydney — Collex uses outsourcing so extensively that no IT professionals are on the payroll. Last year, Goodwin signed up Atos Origin, a Netherlands-based outsourcing company, to host, support, and maintain servers running newly acquired software applications from SAP as well as front-office software. So far, so good — but it's early days. "The proof of the pudding will be in the eating," Goodwin says.
Outsourcing sounds good on paper. What company doesn't want to lower its costs? Or at least turn a fixed cost to a variable cost? Or free capital for investment in more strategic initiatives and avoid future investment in new equipment or facilities? US-based Everest Group, a consultancy that helps companies manage their dealings with outsourcing vendors, points out that unit-priced outsourcing in effect translates a fixed-cost infrastructure into a pay-as-you-use, variable-cost infrastructure. In addition, Everest says that when selling the assets or transferring people, the customer enjoys a positive cash inflow, and assets are released for deployment elsewhere in the business.
Vitally, management attention is freed to focus on strategic matters, which can make for good news on the stock front. "I don't know of any company that's had a negative valuation because of a decision to outsource," says Kirk Kramer, analyst with Mercer Management Consulting in Hong Kong. "Stock market analysts like it when companies are able to articulate a strategy that says, 'Here's what we're really good at — what we're going to focus on internally — versus what we think someone else can do better.' " On the other hand, if outsourcing is not part of a coherent strategy, then companies will be penalized.
So far, the record of long-term outsourcing is less than stellar. The track is strewn with tales — some painfully public, most resolutely off-the-record — of botched partnerships. "Outsourcing doesn't work," laments a Hong Kong-based executive at a company that relies on outsourcers for many processes. "Unless you're [straight out of a] cookie cutter, [outsourcing vendors] don't want to know about you," he says, meaning some suppliers don't like to be stretched in awkward ways. Worryingly, this disillusioned manager works for a major communications equipment company — a company that oozes technological expertise.
Some disappointed executives say they have been troubled by reduced access to key data and by vendor inflexibility to their changing business needs. Others claim that as more technologies become commodities, falling costs are not being passed on to them by their service providers. The litany of concerns is rounded out by poor communication, overdependence on the outsourcer, internal resistance, and competition between outsourcers that undermines service levels in the name of price.
Whatever the perils, plenty decide they need all the help they can get. SMI's corporate leadership arrived at such a view. In 1998 the company, which makes steel sheets, plates, pipes, construction materials, and railway products, merged with Sumitomo Sitix to create an entity with combined sales in 1999 of more than $8.5 billion. The merger was part of a push to develop business in other engineering fields, such as manufacture of silicon wafers for use in semiconductors, but it also added to the complexity of disparate IT systems — a problem that threatened to hold the company back.
"Working with IBM will enable us to build an integrated information network for systems that are currently dispersed throughout the country," explains Michio Kubota, general manager of SMI's information systems department. IBM was given responsibility for the development, maintenance, and operation of SMI's existing steel production, sales, distribution, and administrative systems. Management believes that by streamlining and standardizing the software programs used inside the company and by integrating ad hoc hardware systems, the company will boost its productivity.
Far from just passing the buck, SMI believes the move was necessary if it is to secure its place in the new economy. Many industry sectors in Japan have taken a liking to the concept of Web-based vertical industry trading hubs, and SMI wants a slice of the action. The successful transfer of its extended supply chain to the Internet is key. "We intend to link users, trading companies, steel service centers, and affiliated companies via an electronic network," Kubota says. Takao Endoh, general manager of industrial and distribution sector services at IBM Global Services Japan, adds: "We will help SMI to manage its business even better than it currently does."
First Flush of Romance
Mutual backslapping of this kind is to be expected. The honeymoon period is just beginning; expectations are at their highest. But SMI will learn, as countless others have, that maintaining the passion is no easy task.
Outsourcing is a two-way street in which both parties put much at stake. For the customer, it may include selling assets to the outsourcer and transferring staff. The outsourcer may need to make a substantial monetary investment in acquiring assets, absorbing people, and putting in new facilities, equipment, and systems. And none of this happens overnight.
"Time is needed for interpretation and understanding of responsibilities, and for expectations to align on both ends," says David Bell, Hong Kong-based CFO of Manulife Financial, a division of a global insurance group based in Canada. "Relationships and partnership building are the most important factors in an outsourcing agreement. SLA (service level agreement) issues are much easier to manage than soft issues such as people and communication management." Bell says regular communication between senior managers is key.
He should know. Last year, Manulife entered a $13 million, five year arrangement with Sema, a global services company headquartered in London. Under the contract, Sema took responsibility for Manulife's data center facility including mainframe and Unix systems, printing, and network backbone management. The contract also covered data center disaster recovery measures for mission critical applications. But Manulife held on to ownership and control of technical strategy, direction and design, security management, network management, and the help desk. Of the 18 Manulife staffers who worked in the areas to be outsourced, 12 were transferred to Sema. Six stayed behind, along with a dozen technical staffers with functional responsibilities that were not outsourced.
Outsourcing emerged as a viable alternative in 1998, when the company was reviewing the cost-effectiveness of its data center operations. At the time, Manulife was considering upgrading and expanding its existing data center in Hong Kong to accommodate business growth. By that point, the data center had been operational for eight years without major upgrades. The company was also having trouble finding staff for its push to near 24-hour-a-day online services. "Shift operators are much more difficult to hire and retain, particularly for smaller IT operations," says Ellen Mok, the company's CIO. Outsourcing eases that problem for Manulife and brings other benefits, such as automatic access to operating systems upgrades.
"This deal took a lot of time and effort," Bell says. More than a year was spent evaluating the options and hammering out the details. But ensuring that all the elements of a good contract were in place has paid dividends. "We've had a very smooth transition," says Bell. "Our business units are satisfied with the service performance of the outsourcer. Service channels are now more formal, resulting in greater transparency of service tracking and problem reporting for users." Indeed, Manulife is so pleased that the company recently extended its service agreement to cover additional open systems services.
One Man Band
Compared to Peter Goodwin's setup at Collex, Manulife's in-house IT department is huge. Officially Collex's CFO, Goodwin effectively acts as the CIO as well. In larger and more complex relationships, the outsourcer typically creates a dedicated account team, while the customer provides a contract management team. For now at least, Goodwin pretty much is the contract management team.
Collex's small head office reflects a culture that grants tremendous autonomy to its divisions across Australia and New Zealand. Goodwin says this model doesn't support a centralized IT infrastructure, so the company has always relied on contractors or consultants. "In the past we used to host the infrastructure ourselves, but now we've got to the point where we don't even want to host infrastructure," he says.
The initial contract with Atos Origin, signed in June 2000, covered purchase, hosting, support, and maintenance of the hardware needed to run Collex's newly acquired SAP applications for the back office. Goodwin says none of the divisional offices was interested in playing host to technology for the whole company, so it suited them to hand the job to an outside party.
Since then, an industry-specific customer service software package called Refuse Management System (RMS) has been added to the deal, along with software from Citrix which enables delivery of Windows NT-based applications to each desktop. So far, regional server facilities from four smaller states have been consolidated at Atos Origin's facility, while Collex maintains its own server farms in Australia's two most populous states, New South Wales and Victoria. But as the technology becomes obsolete these operations will transfer to Atos Origin as well. "Eventually we'll have all of our IT remotely hosted, managed, and supported by Atos Origin," Goodwin says. "All we'll do — and even then we'll probably use their support — is focus on the content."
In effect, the company is moving from an environment of 30 to 40 server installations to three or four — one for the Microsoft desktop environment, one for RMS, one for SAP applications, plus the corporate Web site. The SAP applications go "live" shortly. The first contract covers just one year; Goodwin expects to extend the terms to three more years, all going well.
But he doesn't expect outsourcing to have a significant effect on staff numbers at Collex. While the company has grown at least 25 percent a year over the past five years, the rate of technology adoption has been even faster: The number of PCs increased by 40 percent in 2000. Goodwin expects efficiencies derived from outsourcing will help keep Collex on that trajectory. Combined with regional autonomy, the previous best-of-breed approach — using different software packages from niche experts — contributed to duplication of effort.
"If we want to control anything more carefully, it's our content, because that's where we see competitive advantage," Goodwin says. "Content" includes information accumulated by finding out a customer's needs, servicing them and issuing follow-up reports. "This is where we want to spend our time and effort — not on maintaining boxes," he says.
Information is Power
Goodwin's focus on the corporate knowledge bank is smart. Inability to access and interpret key data is not only frustrating for executives but life-threatening to any business. Because operational data reflects real costs and actual service levels, it can serve a vendor to keep the figures close to its chest. Depending on the details of the outsourcing agreement, customers might be lumped with raw data and left to come up with their own analysis — a tough feat if operational systems and internal expertise have been transferred to the outsourcer. The issue of data control becomes especially sensitive when a customer is considering changes to its infrastructure that go against the interests of the outsourcer.
Indeed, a company loses control when it loses its understanding of the cost-drivers and limitations of the outsourced process. Everest Group offered counsel to one company whose outsourcer presented it with a one-page invoice — with no more than a single line item for charges — for a $40 million a year contract. When the customer requested detailed information, it was told such information was confidential. After months of pleading they were told the detailed data was not available because the outsourcer did not have the necessary accounting systems.
Eventually the outsourcer delivered a report comprising thousands of lines of detail but no interpretation — and charged the customer $60,000 for the privilege. It turned out that the reports had been available all along — and were being used by the outsourcer to manage the account.
For his part, Goodwin says he is still working out the most effective "carrots and sticks" for keeping his outsourcing relationship in line. He will apply the usual performance measures, such as response time and system uptime, but is more interested in the final service experienced by Collex's customers, not what the Atos Origin-hosted servers deliver to Collex. "Our intention is to structure the final SLA based on the end-to-end service," he says. "If the server farm is running at 98.5 percent uptime, that's fine, but if our clients average only 95 percent uptime, the carrots and sticks will be based on ensuring the 95 percent for our users, in fact rises to 98.5 percent as well." In addition, Atos Origin is keen to buy Collex's equipment, a move Goodwin says he supports in principle. But again, he will not rush. "We don't really want to do that for at least a year," he says.
Real pressure to nail down final SLAs will come if and when Atos Origin assumes responsibility for Collex's network management — a task currently handled by Sydney-based telecommunications company Cable & Wireless Optus. At that point, the outsourcer would have responsibility for Collex's information infrastructure — lock, stock, and barrel. A more complicated regime of financial incentives and penalties would be required. For now, though, Goodwin's outlook is more straightforward. "At the end of the day, the outsourcer will keep our business if they keep their promises — that's the incentive," he says.
Adam Lincoln is an executive editor of CFO Asia.
Accenture (www.accenture.com): strategy and technology management
Atos Origin (www.atosorigin.com): infrastructure and application hosting
Cap Gemini Ernst & Young (www.cgey.com): management consulting, IT services
EDS (www.eds.com): data centers, network management, strategic consulting
iASPEC Technologies (www.iaspec.com): application service provider
IBM Global Services (www.ibm.com/services/): infrastructure hosting, strategic consulting
Infosys Technologies (www.inf.com): software development
National Computer Systems (www.ncs.com.sg): systems integration, data hosting
Oracle (www.oracle.com): ERP applications on tap
PricewaterhouseCoopers (www.pwcglobal.com/us/): strategic consulting
Sema (www.semagroup.com): systems integration, consulting
Wipro Technologies (www.wipro.com): systems design services
Talent on tap comes with some hidden traps. Here are five to watch out for.
Self-absorption. Trouble brews as each party, despite starting with the best intentions, concentrates on its own agenda. The customer feels that it has passed responsibility to another so it can focus energy and time on more strategic aspects of the business. The vendor has its own priorities, not always at one with the customer's.
Inequality. Many outsourcing partnerships deepen and expand with time as companies acquire a taste for easy access to otherwise scarce expertise. In itself, this is not a problem. But companies should watch that they don't let go of areas they did not intend to outsource, or develop a dependency that delivers too much bargaining power to the outsourcer when it comes time to renegotiate contracts.
Noncooperation. Many companies rely on several outsourcing arrangements, yet the history of vendor cooperation is patchy — particularly if they are competitive. Similarly, most outsourcers profit by exploiting economies of scale — they want to get as much activity out of their infrastructure as possible. Often, it is not in the outsourcer's interest to integrate new technologies.
Pigheadedness. Issues of control also arise when the customer wants to modify the behavior of its service provider to meet a new business challenge. Often the outsourcer is the only party that understands what's needed to change the infrastructure. If they are enjoying economies of scale from serving multiple customers, resistance will be all the greater.
Lawlessness. Trouble escalates if employees on the customer side feel that the outsourcer's service levels fall below par. Things get messy when unhappy staffers take matters into their own hands and go off on technology tangents. Not properly coordinated, this creates interoperability problems — and ad hoc patch jobs are never large enough to benefit from economies of scale.
Source: Everest Group