Thesis

Abstract

Business markets are moving forward at break-neck speed and corporations are exploring every opportunity to cut costs and improve their strategic position. Kodak’s endorsement of outsourcing IS/IT in 1990 prompted many small and large companies to embrace outsourcing as a viable strategy to gain capital for modernization and to build corporate information holdings into a strategic asset. The combination of service providers looking for new business and the endorsement from Kodak seemed to kick-start the outsourcing industry and many companies jumped on the bandwagon to outsource at least part of their IS/IT function.

Companies initially focused on outsourcing as a way to cut costs and even used it as a threat to improve internal IS/IT performance. They soon found, however, that a single focus on cutting costs without integrating it into a strategic plan often led to poor outsourcing decisions. Corporate executives have now come to realize that outsourcing IS/IT is one of the most strategic decisions an organization can make and therefore should only be made after the executives fully understand the company’s internal workings, have a strategic plan in place, and have defined the corporation’s vision for the future.

Outsourcing is not a panacea for problem areas of the firm, particularly financial problems, but it may be a desirable alternative if real savings are possible, contracts are strictly enforceable, and the strategic mission of the firm is not impaired or may gain from new thoughts and innovation. As companies gain experience in outsourcing IS/IT, there is a strong consensus that it is far more important to focus on the long-term effects of outsourcing rather than the short-term financial savings. There is also no single outsourcing solution that is right for every company, so executives need to be prepared to clearly state their objectives and requirements and then seek the right vendor who is willing to work with the customer in a "partnership" to achieve those objectives.

Outsourcing contracts can be up to 10 years long, so it’s imperative that the company selects the right vendor the first time. When reviewing potential vendors, company executives should look for a vendor who has similar operating styles and cultures at all levels of the organization to increase the chances of developing a successful relationship. The vendor must also be competent to meet the company’s requirements in the near-term as well as into the future. With technology and markets changing so rapidly, it’s essential that the vendor be able to adapt quickly to changes and maintain or even gain market share. The essential element is creating a win-win relationship where the vendor and customer work together to optimize performance, create innovation, and stay ahead of the competition.

The internet has changed everything about the world as we know it (e.g. communication, commerce, and business) including the rules of competition and barriers into regional, national, and global markets. At one time, companies could dictate their own pace of change, however, today that pace is driven by customer demand. The internet has totally changed customer expectations regarding convenience, speed, comparability, price and service and has driven companies to either meet those raised expectations or be pushed aside by the competition. Most companies failed to anticipate the demand and are now forced to use outsourcing to keep pace with growing demand. With the expansion of the global economy, strategic outsourcing with multiple vendors will enable companies to offer the best capabilities in virtually every functional area.

Definition and Background

The term outsourcing is generally defined as contracting with outside vendors to do various Information Technology (IT) functions, such as data entry, data center operations, application maintenance and development, disaster recovery, and network management and operations. Vendors may be individual IS/IT professionals, consulting firms, employee leasing companies, full-service providers, or even CPA firms. Outsourcing as a function has been around for several centuries, but possibly one of the earliest forms of outsourcing occurred in 1476 when monks recognized they could not do all their printing themselves and solicited the services of several printers in their press.

In general terms, outsourcing is the time-sharing strategy that was used during the 1960’s and 1970’s, but with a slight twist. With the time-sharing strategy, customers seeking assistance were at the mercy of the vendor because the vendor was responsible for all the design, development, and control of their systems. With outsourcing, the customer can design and develop their own information systems and simply outsource the tasks of managing, updating, and maintaining the systems to a vendor.

With the invention and evolution of the computer, companies have continued to expand their dependence on IS/IT. The demand for accurate, current, and accessible information has skyrocketed and forced companies to create new innovations to stay ahead of their competition. Companies recognize information systems and information technology are critical strategic assets and understand that they must explore every opportunity to achieve or maintain a competitive advantage. Most companies have found that contracting with an outside vendor to provide all or some of the IS/IT service can posture organizations to keep up with the fast pace of today’s marketplace while simultaneously freeing-up scarce resources to keep pace with constant breakthroughs in technology.

Outsourcing is often seen by companies as a way to reduce costs, but this narrow focus ignores the long-term implications of IS/IT as a strategic asset. Companies have frequently stated off the record that IS/IT is well known for the enormous demands it places on limited capital investment budgets, cost and schedule overruns, and its inability to clearly show that it increases company profits. If a company can outsource the function, reduce costs, improve its balance sheet, and avoid or reduce the requirement to deal with all the technical jargon, why not make it happen? No business understands the function, so how can the company effectively manage their information?

There was a time when business managers wanted to vertically integrate everything and create many small inefficient functions. Companies eventually found that strategy to be extremely inefficient and recognized that they are unable to do everything in-house. With vendors looking for business and companies recognizing they couldn’t do everything themselves, outsourcing was a "perfect" match. Unfortunately, there are significant risks in outsourcing a function that directly affect quality and customer service when that is the focus of today’s market. Who wants to depend on outsiders to deal with critical customers or storing, manipulating and retrieving data that is crucial to meeting customer service demands?

Major IS/IT outsourcing decisions have a strategic impact on the company and should never be made before the company has a complete strategic plan that details the company’s vision, mission, core competencies, and key success factors. Outsourcing a function that could eventually become a core competence or a key success factor because it would reduce costs may solve a short-term cash problem, but simultaneously create a long-term problem that could eventually ruin the company. An informed decision regarding outsourcing IS/IT depends on having a solid understanding of some fundamental factors that include:

The overall consequences of any make-or-buy decision

Clear understanding of what constitutes a core competency

An assessment of IS/IT as a future key success factor, even though it wasn’t in the past

The new skills and attitudes that are required for effective outsourcing.

Alternatives to outsourcing.

Consequences of a Make-Or-Buy Decision

On the surface, outsourcing may look like a simple make-or-buy decision, but this view does not recognize the long-term implications of the decision. Even in the simple case of a decision to make or buy a part or component, the company should never limit its options by doing whatever costs less. When you choose to go to an outside agency (buy), you have basically denied yourself the opportunity to have both options (make or buy) in the future. With every "buy" choice, the capability to do the project in-house is significantly less and eventually the loss of expertise and cost to rebuild the expertise will always make it cheaper to buy. Soon rebuilding IS/IT expertise is no longer even feasible and the company will be forced to buy whatever it needs for the going price.

Secretary of Labor Robert B. Reich described a situation in which a company's engineers complained that "The company thinks it's cheaper to buy rather than build, and it is today. But if we don't make it in-house, we don't gain the experience and knowledge that goes with making it. And then we can't develop a whole range of technologies that are likely to evolve from that component (16:60)."

What is a Core Competency?

It is extremely important for companies to focus on their core competencies when exploring outsourcing decisions. Today, most companies follow the philosophy that the company should retain all core competencies and outsource everything that does not fall in that category. Unfortunately, most senior leaders don’t completely understand the true definition of a core competency and therefore almost always consider IS/IT a non-core competency. Just because a business does something well now doesn't necessarily mean it should be a core competency, even if that activity provided significant competitive advantage in the past. On the other hand, just because something has not been critically important in the past does not mean that activity will not become a core competency in the near or distant future. Here are some definitions that may provide greater insight the significance of a core competency:

Evolved slowly through collective learning and information sharing

Cannot be quickly enhanced through additional large investments

Is synergistic with other capabilities

Cannot be easily imitated or transferred to others

Confers competitive advantage in the perception of customers.

Can be a key success factor for the industry

Cannot readily be divested

Many corporations do not categorize IS/IT as a core competency, but if you look closely, IS/IT typically has many of the traits listed in the previous paragraph. For example, IS/IT often meets the first three criteria, and significant elements of IS/IT (e.g. applications development) usually meet the fourth. IS/IT frequently has the potential to meet the fifth and sixth criteria as well. If IS/IT currently is, or very close to becoming, a core competency , senior company leaders need put some long hard thought into outsourcing risks and benefits when someone recommends outsourcing IS/IT functions because it’s a "no-brainer" or because it’s a bothersome service function.

A Future Key Success Factor

Now that we are in the information age, corporate managers must seize every opportunity to develop business systems that fully exploit business and customer information to achieve a competitive advantage. So why would companies throw away the opportunity for product and services innovations by completely outsourcing their IS/IT capabilities? Will the cost savings be large enough to offset any loss of innovation? Companies who focus on maintaining the status quo typically are unable to keep up with the business markets so even if they have the lowest costs, they may be far behind their competitors for achieving customer satisfaction.

The growing trend is to keep key IS/IT functions in-house while outsourcing support functions. Most large organizations do not outsource critical elements of IS/IT such as the development of new applications, so many innovations can still be created after some IS/IT operations are outsourced. However, when it comes to IS/IT expertise, there is really no way to ensure that the company retains the necessary capabilities and people and outsource the rest. A wrong decision could result in the loss of a capability that could have become a key success factor in the future. Once the expertise is gone, it often to costly or time consuming to even attempt to build it back up.

Skills and Attitudes for Effective Outsourcing

Outsourcing is often viewed as a way to reduce costs and a strategy for management to avoid the headaches associated with IS/IT. While outsourcing may initially appear to solve those problems, it also creates new challenges. Because of the complexity of outsourcing, companies must develop new skills and methods that increase costs and potentially create more. Vendors attempt to sell outsourcing contracts as "partnerships", but generally vendors are only motivated by their own profit.

Many organizations have several IS/IT outsourcing vendors--one for data center operations, one for network administration, and one for disaster recovery. Managing a single large, complex outside vendor relationship can be very challenging, but managing multiple vendors may overwhelm the company. Once IS/IT is outsourced, top management loses its direct command authority over the function and every special or emergency request becomes the subject of a change proposal that must be formalized and negotiated. In fact, many government contractors "buy into" contracts with unrealistically low prices, then profit on the changes that are required to maintain complex systems under long-term contracts. The bottom line is that the company must be prepared to effectively manage any outsourcing contract to achieve the greatest return.

Alternatives to Total Outsourcing

With information being one of any company’s most valuable assets for achieving corporate goals, outsourcing IS/IT may not be in the company’s best interest. But what if a company determines that IS/IT is not now, and never will be a core competence in the future? Does that mean that the company should automatically outsource? The key is to look at the total impact of what would happen to the company’s awareness of the latest technology. How will the organization stay abreast of the latest technological opportunities when it has very few or no specialists with intimate knowledge what technologies are being deployed or developed for the industry? Hardware and software vendors quickly learn which companies have stopped purchasing and soon stop calling. IS/IT executives who once viewed sales people as irritants now feel left out and unaware of the latest developments.

Fortunately, there are more alternatives to outsourcing than just the status quo. Companies should first streamline its IS/IT processes (e.g. redesign, new training, quality programs, and incentives) to ensure they have done all they can to increase productivity and reduce costs. If streamlining fails to achieve the desired results, the company should then consider partial outsourcing where the organization develops new and potentially important systems within the company while older and less strategic legacy systems are outsourced.

Another alternative is the exact opposite to outsourcing and is called insourcing. Insourcing allows a company to build a project in-house that would provide a unique service to outside organizations. However, before this strategy can be implemented, internal clients must be completely satisfied that they are fully supported by their IS/IT organization. It is more important that the IS/IT function help internal clients to succeed than to have the IS/IT organization make money on its own. Companies are typically focused on supporting internal clients who provide value added service, however, that may change if the IS/IT commodity becomes something that the industry demands.

Outsourcing Benefits, Risks, and Economics

In many outsourcing decisions, interest originates from pressure by senior executives who use outsourcing as a threat to force change within the IS/IT organization and across the company. Outsourcing vendors promise dramatic savings and greatly improved flexibility that will allow line executives to have more time to concentrate on their core business areas. At first glance, these claims may seem possible, but the company needs to see the entire picture and consider the associated risks.

Potential Benefits of Outsourcing

Advocates of outsourcing cited the following reasons for choosing outside vendors:

The volatility of information technology can quickly make IS/IT skills obsolete. Software is updated and replaced so rapidly that by the time a company trains its full-time staff, the technology may no longer be state-of-the-art. Well-trained outsourcing specialists can provide immediate support.

Fierce competition has led many businesses to restructure and downsize staffs to save money. Even thriving companies look for every opportunity to reduce staff and costs. Vendors may save money because they have tighter controls on benefits and run very lean overhead structures.

Vendors seize every opportunity to reduce costs. Vendors can often save money by merging datacenters into low-cost areas and using bulk purchasing and leasing arrangements to acquire all hardware and software. At the same time, they bring well-trained personnel to support the customer’s existing IS/IT staff and are obligated by contract to meet deadlines.

Companies must have IS/IT functions that are flexible enough to adapt to a constantly changing business environment. Vendors can often access a wide range of resources, skills and capacities that may be unavailable to internal IS/IT staff.

Vendors often hire outsourced staff with the understanding they'll be employed for a limited time. The outsourced workers can then be used as a buffer to meet fluctuations in demand and enable the company to build a strong relationship with its internal workforce.

Reality of Claims

As users become more aware of the possibilities and limitations of information technology, they often criticize the support that supposedly exists, but never appears. A recent outsourcing study revealed that a majority of senior managers viewed their companies' IS/IT functions as cost burdens rather than strategic resources. The managers also perceived internal IS/IT departments as being outdated, inflexible, expensive, unmanageable and lacking customer focus.

With those findings from the study, it’s no surprise that outsourcing has expanded so much, but there is no conclusive proof that outsourcing will fix all IS/IT problems and lead to a more focused organization. The media and company public relations offices tend to focus on the benefits of outsourcing, but often fail to reveal the significant risks, disadvantages, and sometimes considerable hidden costs. Managers frequently reported huge success stories when the outsourcing contract was first signed, but the public never heard the complete story because companies don’t want to advertise their mistakes. Unfortunately, many organization fail to fully research outsourcing decisions and don’t find out about the considerable risks until they have already signed an outsourcing contract.

Economies of scale (The theory that states large companies can achieve lower average costs than small companies due to mass production and labor specialization efficiencies) may clearly create reduced costs, but the vendor must still earn a profit at the customer’s expense and managing external contracts nearly always brings additional costs. Most savings from outsourcing typically result from consolidating data centers, however if the customer has already consolidated its own data centers, then outsourcing may actually even increase costs. The only long-term cost savings occur when economies of scale cross several functions (e.g. long-distance communication). Vendors also suggest they can provide customers with better access to new technologies, however that better access may limit the company’s ability to exploit opportunities offered by competitive vendors.

Some people say that outsourcing gives the customer greater financial flexibility, however, a 10-year contract may actually restrict flexibility and increase costs. Renegotiating any contracts could become fare more expensive than changing internal commitments. If flexibility is the goal, then the customer must negotiate the contract to allow flexibility at a reasonable cost (unfortunately, flexibility often equates to high costs). In a few cases, outsourcing has provided a source of near-term cash as IS/IT assets may be sold to the outsourcing vendor. This might provide short-term relief, but selling a strategic resource is probably not the best strategy to save a sinking ship. In some cases, outsourcing is simply a matter of paying someone else to experience the pain of managing a dysfunctional IS/IT function, rather than trying to figure out how to turn the function around.

In organizations that must downsize, outsourcing may look like an ideal way to reduce the number of personnel and have the vendor reemploy the excess workers on another contract. In reality, if the personnel are qualified, they will get the jobs on their own and if they are unqualified, it’s unlikely the vendors would retain them. Ultimately, outsourcing does little to change the employment picture for surplus IS/IT professionals. Companies that outsource are often surprised to find that the vendor they hired is not the one working on their projects. Because of the difficulty vendors have in attracting highly skilled workers, the vendor is forced to subcontract business to small, unknown companies, often without informing their clients. These subcontracts can create problems with maintaining standards, establishing effective communication, ensuring quality service.

Vendors often suggest that outsourcing frees business managers to focus on the corporation's core business processes, but this will only happen if IS/IT managers are transferred into other business functions. If IS/IT managers are fired or transferred to the outsourcing vendor, the company will still have the same number of business managers focused on core processes. In other words, the business only gets more attention if line management is expanded (and costs are increased). Of course, line managers can be added regardless of whether IS/IT is outsourced.

Some organizations are attracted to outsourcing because it relieves senior management of having to worry about managing its IS/IT function. The argument is that outsourcing reduces the demand on senior management because a contract is substituted for direct authority. Unfortunately, managing an outsourcing vendor is no easier (and often more difficult) than managing an internal IS/IT executive. If senior management becomes less involved in managing IS/IT, outsourcing may actually cause more problems than it solved. People who recognize the strategic value of IS/IT believe management should even more, note less, time thinking about IS/IT. Without management involvement, the IS/IT function will never achieve the innovation required to find breakthroughs in strategic applications.

Insider Advantage

Continuity and vested interests are two key reasons why personnel already in the company have an advantage over people brought in by outsourcing vendors. Internal staff has the experience and continuity with the organization that virtually always results in a better understanding of the business and improved relationships with clients. They know they will be the ones who will have to deal with the eventual consequences of their actions, so they put in extra effort to get things done quickly and done right the first time.

Vendors often indicate they can meet the needs of the company on the first day of the contract, but this is virtually impossible. Unless the vendor’s personnel worked in an identical business with identical technology and personnel, there will be a significant learning curve for the first six months. In addition to the steep learning curve, the vendor often services multiple contracts and finds it quite easy to rotate their staff. Since the loyalties of the vendor’s staff lies with the vendor, the customer seldom may not receive the vendor’s services as advertised and often has to fight for resources that the business no longer directly controls.

Outsourcing vendors may be sincere about creating a partnership, but ultimately the vendor works for different shareholders and must place their shareholders' interests first. For example, what would happen if the IS/IT consultant sees an opportunity for either a $200,000 administrative application that could save administrative time or a $200 end-user computing tool that could greatly enhance the client’s overall effectiveness? Even though the $200 tool would provide significant payoff for little investment, the outsourcing vendor has a strong incentive to recommend the high-cost and little payoff project because it will create greater profit for the vendor.

Offshore Outsourcing

With the IS/IT labor market tight at home, companies are looking globally to find qualified help. The promise of faster and less expensive IS/IT work has lured both large and small companies to outsource work overseas. The potential rewards for using offshore outsourcing are great, but the associated headaches are often equal or greater.

As technology improves and success stories emerge, the practice of offshore outsourcing continues to grow. "There are lots of good reasons," says Erran Carmel, a professor of management of global information technology at American University. "Number 1, the telecommunications infrastructure is allowing it. Number 2, we have a software labor shortage all over the developed world that is creating pressure to go abroad. Number 3, we have the issue of costs in some cases (22:2)." Offshore outsourcing can save money and get a project done on time, but it will only be successful if a company begins with the right kind of project; closely manages it, and recognizes the logistical, political, and legal risks from the beginning.

The first step toward successful offshore outsourcing is to make sure the project lends itself to being sent abroad. Things that require frequent interaction or are not clearly defined would not be good candidates to be sent overseas. However, well-defined application maintenance or Y2K projects would be ideal as the overseas company could work those projects with only periodic updates and occasional intersite interaction.

Both the offshore outsourcing vendor and the local company must ensure they are moving forward on the project simultaneously. If the offshore location gets too far ahead on the production without quality control from the local company, significant time and capital could be lost to get the companies back on track. Local companies typically complete all the design, specifications, and testing with the offshore company focused on completing the more repetitive tasks that don’t require constant oversight.

Support for real-time activities by offshore organizations was extremely difficult in the past because of the large time difference between the two locations and the need to physically see the problem. That all changed with the advances in computing and telecommunications that now make it possible to send help desk and even internet support offshore. With adjustments in work schedules, offshore companies can readily support many projects that were previously limited to only local support.

On the surface, it appears that offshore outsourcing would save a great deal of money because labor costs in offshore locations is significantly less than in the United States. However, labor is just one of the costs that need to be considered. "Generally, outsourcing abroad as a way of reducing costs is not a very good strategy," says Avron Barr, co-director of software research for the Stanford Computer Industry Project, in Stanford, Calif. "Even if the labor rates are less, some middleman has made up the difference by the time they're done. If they haven't, you should be worried about quality." "Most companies report between 35 percent and 50 percent savings, but the key is to choose the projects wisely (22:3)."

Offshore outsourcing also has legal and political limitations. One reason that most companies using offshore outsourcing go through a company based in the United States is so US contract law applies if the project fails. No matter where the company is located, a certain percentage of its projects will fail. However, if you are dealing with an overseas location, you need to have someone you can sue to recoup the investment plus damages. Companies must also consider the potential for political problems. When India began nuclear testing and the United States responded with sanctions, it put many companies in a temporary holding pattern until the situation was resolved. The incident had little long-term effect on the market, but it provided a clear example of how quickly conditions overseas can change. One of the most important things a company can do is create a back-up plan in case something goes wrong and cannot be resolved quickly.

The following are good candidates for offshore outsourcing:

Application development and maintenance

Bug fixes

Call center

Data entry

Mainframe work, especially year-2000 conversion

System maintenance

When Outsourcing Makes Sense

Most firms do not want to totally divest their IS/IT function because they wanted to control their destiny and maintain a robust staff of well-trained personnel. Instead, they chose a selective outsourcing strategy with the following goals:

Minimize staffing fluctuations that could result from rising and falling demand

Maximize employee development by outsourcing less interesting work

Minimize costs by using less expensive employees when possible or sharing costs

When capital is short, outsourcing may provide a way to satisfy temporary needs. This is particularly true when a company migrates to a new system and must continue to operate the old system during installation and testing. Inside staff should be the first line of support, with external resources used for actions that the company cannot handle. No matter how big the IS/IT organization, it can’t afford to hire a specialist for every possible situation. Vendors can fill that gap with specialized expertise in seldom used areas and allow applications technologists to focus on new requirements. Generally, the following guidelines apply:

Hire enough staff to satisfy standard demand and outsource to satisfy peak loads;

Outsource only commodity and end-of-life services while keeping new growth opportunities

Managing Your Outsourcing Vendors

In order to control the costs associated with hiring an outsourcing vendor, the company must create a strong outsourcing management team to oversee the transition. Failure to put the effort in up front before the contract is signed often results in even greater costs for contract changes. The following list details the responsibilities for managing outsourcing contracts:

Shopping for the best deal, negotiating the contract, and managing contractor performance

Resolving problems in the relationship and maintaining healthy collaboration

Generating entrepreneurial ideas within the a clear charter and deciding whether to "make or buy"

Establishing and fulfilling detailed agreements with internal customers and suppliers

Identifying Costs

Companies may believe that outsourcing will drastically reduce IS/IT costs, but there are many situations where companies found that costs actually increased. By considering the full scope of contractual costs, transaction costs (e.g. cost of entering and enforcing a contract), and coordination costs (e.g. cost of exchanges across the life of the contract), outsourcing can actually cost more money than keeping the function in-house.

Before any company even considers outsourcing as a solution, senior management must reduce or even eliminate all non-value-added costs. For example, non-value-added order costs could be reduced through electronic data interchange (EDI). Outsourcing vendors typically eliminate those same costs from their proposal, so the only way a company can compare internal costs to vendor costs is to ensure they have done everything to streamline their operation.

Entering and enforcing contracts can also be costly. When Continental Bank outsourced its IS/IT functions, there were associated costs for technical employees drawn from all areas of the bank's staff over a two-month period. In addition, top management and outside consultants spent an additional three months soliciting proposals. When Kodak outsourced its IS/IT function, it had hundreds of people involved in contract evaluation and bargaining. Along with the hidden transaction and coordination costs, companies must also consider the costs associated with risks such as the loss of proprietary information, financial stability of the supplier, and unwillingness of the supplier to invest in new technologies. After all associated costs are considered, savings from outsourcing may be virtually eliminated.

With technology changing so rapidly, an evaluation of today's cost structure may not be representative of future costs. With contracts typically lasting for five to ten years, costs for hardware and software, computer-integrated manufacturing components, and industrial and commercial electronic applications could be drastically different from the first half of the contract to the last half. The bottom line is that companies should never enter into any outsourcing agreement without first completing a comprehensive cost analysis of production, transaction, and coordination costs. Once all the hidden costs are identified and factored in, what initially appeared to be appealing may actually turn out to be a poor strategy.

Control Mechanisms

If a company discovers that its internal IS/IT department is really not cost competitive, it may be in the company’s best interest to outsource. But before any outsourcing contract is executed, the company must understand all aspects of associated costs and build in several control and monitoring systems.

The company should contract with the outsourcing vendor to meet agreed-on performance goals throughout the life of the contract. These goals should be audited on a regular basis, and incentives should be identified for meeting the objectives. Where technology is highly uncertain, the duration of the contract should be shortened to reduce the risk of giving the outsourcing vendor all of the benefits of the contact. For example, companies may have justified a ten-year information system outsourcing decision in a mainframe environment, but migration to client/server architecture puts all the cost advantage with the outsourcer. Generally, the greater the uncertainty, the shorter the contract should be.

Strategic Direction and Alliances

Many companies focus on the short-term cost and cash flow affects of outsourcing rather than looking at the longer-term impact. Troubled firms with cash-flow problems often consider outsourcing to cut excess debt. As Ray Mangarelli, President of Gateway Consulting Information Service explains: "The front-end incentives and near-term cost reductions of long-term outsourcing contracts are very seductive. Several years into the contract, however, the economics are troubling at best and extremely costly at worst (5:5)."

Based on an outsourcing survey of 1,700 chief information officers in 1995, Gateway Consulting found that none of the ten-year contracts signed in 1992 will remain untouched. Based on the drastic changes in technology, it is very likely that more contracts will unravel than be signed. The majority of the firms surveyed also indicated that their strategic focus was limited to three years because customer demand information and projections on costs and future technology were so hard to predict. Based upon this survey and preceding information on hidden costs of outsourcing, it’s clear that focusing on reducing costs without integrating all actions into a strategic plan will surely lead to a misinformed outsourcing decision.

When considering outsourcing, managers musk ask themselves whether their suppliers will end up competing against them down the road if design, manufacturing, or assembly are outsourced. Generally, unique skills and competencies, high value-added processes, and cutting-edge technologies should not be outsourced. However, mature products or processes (i.e. many suppliers) are strong candidates for outsourcing. Strategic alliances provide an alternative to outsourcing when the company feels its core technologies and skill advantages could be at risk in a standard outsourcing agreement. By forming a strategic alliance, companies create a win-win situation that increases market potential, expands economies of scale, and allows both companies to share the profits and the risks. This is particularly true in the global market where companies need to have an in-country partner to break through the bureaucracy and achieve the greatest exposure.

Biotechnology, semiconductors, and electronics are only a few areas where strategic alliances are increasingly common. The key is to use each company’s strengths to develop, manufacture, and get the products on the market before the competition has a chance to gain significant market share.

Strategic Intent for IT Outsourcing

Nine years after Kodak energized the marketplace by outsourcing major components of its IS/IT function, the IS/IT outsourcing industry is booming. Industry analysts predict that the global market will grow from $86 billion in 1996 to more than $137 billion by 2001 (see figures 1 and 2). Outsourcing arrangements for hundreds of millions of dollars are now dwarfed by recent deals by J.P. Morgan, Dupont, and Xerox Corporation for billions of dollars. A 1996 survey of 450 information systems executives in North America and Europe found that nearly 50 percent of the respondents were planning to engage in outsourcing during 1996, and another 25 percent were considering it (see figures 3 and 4).

IS/IT is essential in business initiatives such as reengineering, knowledge management, the creation of electronic distribution, and the development of digital business strategies. So why are so many companies outsourcing their IS/IT activities when it has never been more critical to business success? Even large companies such as Dupont, British Petroleum, and J.P Morgan that have innovative IS/IT departments and are fully capable of achieving economies of scale and specialization recently locked-in large outsourcing contracts. As the importance of information continues to grow, the pace of business races forward, and communications technologies rapidly expand, companies are finding a wide gap between their existing capabilities and those required to achieve their full potential. Many large and small companies have turned to IS/IT outsourcing as a strategy to close that gap.

A large number of companies still follow the traditional outsourcing model where the company contacts an outsourcing vendor to perform required IS/IT functions. However, more innovative companies are developing new models to combine the abilities of the company and outsourcing vendor to create a strategic advantage. Dow Chemical recognized it was losing key IS/IT staff so it created an outsourcing joint venture to increase career opportunities and gain access to more skilled workers. Philips Electronics decided to outsource its systems delivery through a joint venture with a software and systems integration company and in the process became a new provider of IS/IT outsourcing services. CNA Insurance established a new life insurance business processing service with its outsourcing partner as a part of a huge long-term datacenter outsourcing deal. Companies with a long-term focus have taken outsourcing and transformed it into business venture rather than just a service provider.

Three Strategic Intents

Companies still look to outsourcing to provide short-term results, but most large companies are now looking to outsourcing as a strategy to achieve a strategic advantage. The most well-know intent of outsourcing is IS Improvement where a company reduces costs and enhances the efficiency of its IS/IT resources. Two other strategic intents recently emerged as critical factors in determining whether or not to outsource IS/IT functions. Outsourcing for Business Impact focuses on improving IS/IT's contribution to company performance within its existing lines of business, while Commercial Exploitation focuses on exploiting company technology-related assets (e.g. applications, know-how) by developing and marketing new technology-based products and services.

The most important element is that the relationship with the vendor (e.g. contract type, decision rights, performance measures, and risk-and-reward schemes) has to be aligned with the strategic intent of the outsourcing initiative. Outsourcing agreements that achieve poor results are often the result of a failure to address the following issues:

Clearly define the intent and specific goals for outsourcing

Align the contract and relationship with clear strategic objectives

Build flexibility into the contract to adjust to adjust to business or technology changes

Ensure that the vendor is capable of meeting the outsourcing objectives

For example, incorporating performance measures or compensation schemes built for IS Improvement (cost cutting and efficiency) when the company had another strategic intent could be counterproductive and create friction for both organizations. If a company is looking for innovation to develop new systems, the contract needs to identify things that will encourage and reward risk-taking. If a company is trying to achieve multiple objectives, the outsourcing contract must be even more detailed to address each situation and create a strategy that will encourage each vendor to achieve their specific objectives.

Another thing to consider is that a company’s strategic intent often changes over time, so it’s imperative that the outsourcing relationships are flexible enough to remain aligned with the new intent. For example, companies typically begin using outsourcing to improve things they were already doing and to bring in new skills and tools. However, as the business changes, outsourcing objectives may expand to creating and delivering IS/IT benefits that were never done before. The challenge is to design a contract and relationship so the client company can achieve its objectives with continued support from the current vendor. The key to success if for parties of an outsourcing agreement to clearly understand all costs associated with the services, recognize the risks to each side, and fully understand how the companies will work together to achieve the desired objectives

IS Improvement

Companies wanting to optimize their IS/IT resources (e.g. the hardware, software, networks, people) have a strategic intent of IS improvement. They are focused on reducing costs, improving service quality, and bringing in new technical and management expertise. They believe outside specialists can better handle new technologies and provide superior processes and management methods.

This strategy’s success comes from achieving economies of scale, implementing cost reduction and service improvement, and bringing in technical expertise. Unfortunately, this strategy can also lead to failure if the company does not get the skills it requires, there are cost shifts instead of real cost reductions, and coordination costs exceed the savings from outsourcing. Management control mechanisms (contract type, performance measures, reward and penalty schemes, and decision structures) need to focus on IS/IT services (e.g. network provision, datacenter operations, applications program maintenance, and new systems development. Performance metrics include network response time, problem-resolution cycle time, cost per user, and function points.

Vendor compensation is typically based on a pricing schedule for technology services. It is often difficult to determine future costs, so it is critical to create a very competitive vendor selection process to ensure costs are competitive. Companies also need to incorporate frequent benchmarks into the contract to allow renegotiation if there is a substantial change in business and technology conditions.

The relationship should depend on the risks and uncertainty associated with delivering the outsourced services. When requirements are well defined and outcomes observable, the relationship should focus on contractual elements. However, when there is uncertainty about requirements, a partnership approach may be more desirable

The requirement for success is to strike the right balance between risk and reward for both the vendor and client, and ensure that the client is significantly involved in any improvement initiatives. Transferring ownership and responsibility for IS/IT assets from the customer to the outsourcing vendor is extremely important as ownership provides the incentive to continue investing in those assets.

Business Impact

Many IS/IT organizations are finding it very difficult to find the right blend of technical and business skills to fully exploit today’s technology. As a result, companies are looking to IS/IT outsourcing for help. The primary goal for the business impact strategy is to fully integrate IS/IT to significantly improve critical business performance. This goal requires not only an intimate knowledge of the business and the link between IS/IT and business processes, but also the ability to simultaneously implement new systems and business change. The most effective approach focused on jointly developing skills and capabilities that complemented the company rather than relying solely on the vendor.

The involvement ranged from better alignment of IS/IT resources with business needs to the delivery of new IS/IT-based business capabilities and competencies. Many organizations must simultaneously create new IS/IT capabilities to compete in the digital world while continuing to maintain the status quo. Most companies lack the technical talent, management skills, and financial resources to do both, but outsourcing can be used to fill the gap and support the current operation until the new equipment is in place personnel are ready to support the new systems.

Xerox decided to outsource as part of its move to completely change its IS/IT assets. Outsourcing enabled the company to completely reengineer and retool its business capabilities and provide a new career path for 70% of its IS/IT personnel. This drastic move enabled the company to free-up financial and management resources to focus on creating IS/IT infrastructure and applications for future business and building new for the IS/IT staff who remained. According to Jagdish Dalai, a Xerox executive, "I would not have even thought of reengineering if we hadn't outsourced, because we would have been busy reorganizing, letting people go, consolidating data centers, whatever. Xerox had to reduce its IS/IT spending and redirect it, and the best way to do that was outsourcing."

The contract addressed the company's cost and service objectives, but more importantly, it liquidated a major portion the company’s IS/IT assets to provide capital for new IS/IT infrastructure and reengineering systems and processes. Xerox's main challenge was to build new systems fast enough to retire the outsourced legacy applications in time free-up capital to fund additional systems development.

Occasionally companies that outsource IS/IT for business impact request their vendor not only implement new systems, but to take on further responsibility for implementing changes in the business. A few companies have gone even further and commissioned their outsourcing partner not only to deliver IS/IT to improve business processes, but to operate and manage those processes as well. This growing area of business process outsourcing is opening new doors for outsourcing vendors as they expand their capabilities in areas such as insurance claims processing, logistics, payroll, airline operations, power distribution management, and so on. It is an attractive market for IS/IT outsourcing vendors because the profit margins are significantly higher than the markets for pure IS/IT services.

Business impact is a significant and expanding objective for IS/IT outsourcing and has created a fundamental change in the relationship between the user and the vendor. In order to gain the most from this relationship, the agreement must emphasize shared risks and rewards tied to business results. A conventional outsourcing contract for simple transactions and services will not capture the intent of the agreement and show the relationship between the risks and rewards. This arrangement calls for giving the vendor incentives to learn about the customer's business while still requiring the vendor to meet current IS/IT requirements. If specialized knowledge of the business is critical and tight control is essential, then a strategic alliance or joint venture may be required.

Success factors are more business oriented and typically address understanding the operation, fitting IS/IT to business needs, managing change projects, and having the right balance of management and technical expertise. Pricing provisions should tie vendor compensation to value received and payments and incentives should be determined by business process performance and results.

Commercial Exploitation

Outsourcing information technology with the strategic intent of commercial exploitation focuses on improving the return on IS/IT investment by creating new profit or offsetting costs. Companies using this strategy can achieve these gains through licensing systems and technologies initially developed for internal use, selling IS/IT products and services to other firms, or even launching new IS/IT businesses. Companies pursuing commercial exploitation come from industries such as air transport and financial services that have expensive mission-critical systems, but see the potential of significant revenue if they develop new technologies that become industry standard.

Most companies don’t have the expertise to maintain existing complex systems and implement new ones and even fewer companies have the capabilities to market, install, and support products originally developed for internal use. One way to gain those capabilities is through relationships with outsourcing vendors. As IS/IT becomes more integrated with business processes and distribution and communication channels become electronic, the market potential for industry-specific applications becomes huge. Sharing the costs and risks of commercialization with outsourcing partners can help maximize return on IS/IT investments. For their part, the outsourcing vendors look to client firms as unique sources of the industry-specific expertise and technology assets that are critical to developing new innovative systems in complex industries.

The most common aims are to gain revenue by selling existing IS/IT assets (applications systems, access to infrastructure, technical expertise) to other companies. More ambitious objectives involve attempts to restructure industries by building new e-commerce or distribution channels (such as Web-based travel reservation systems and on-line trading) and creating entirely new IS/IT businesses (typically, applications software, IS/IT consulting, and business process outsourcing).

All companies considering IS/IT outsourcing should be aware that their vendor may look for ways to use the assets it acquires to service other accounts or by selling or providing other firms access to them. Companies need to realistically assess the potential commercial value of outsourced IS/IT assets and understand how the vendor intends to use them. All of that needs to be factored into a contract by increasing the amount the vendor pays for the assets, discounting the service price, or by establishing an arrangement to share the revenues.

Because of the risks and rewards associated with commercial exploitation of IS/IT, the issues of sharing and control are unique. For these deals to succeed, they must contain sufficient incentives for each party to share the costs and risks over the course of the relationship. Given the uncertainty in required investments and underlying risk and potential payoffs, it is extremely difficult to write a contract that specifies each party's commitments for the future. Relationships should be built around strategic alliances, joint ventures, and joint ownership arrangements that align incentives at the level of business outcomes. In managing the relationship with the outsourcing vendor, companies should focus performance metrics on results such as new revenues, net profits, gains in market share, launch rate of new products and services, and development of new businesses and market channels.

When commercial exploitation is the strategic intent for outsourcing, product development, technical innovation, and sales and marketing become key determinants of success. The primary obstacles to success revolve around failing to realize synergies of assets and capabilities, failing to fulfill commitments to internal customers, and maybe the most critical, ensuring rewards received by the partners are commensurate with the risks each assumes. These ventures will not work unless each party makes a significant investment of management and staff, technology resources, and funding. Success requires courage and patience to make a long-term commitment, an ability to assume greater risk in return for potentially greater rewards, and IS/IT assets and capabilities with clear value in the marketplace.

Innovation and Outsourcing

"Innovate or die." That was the rallying cry of software firm Microsoft and its founder Bill Gates. At a recent Senate Judiciary Committee hearing, Gates pressed his point by saying, "All of us at Microsoft understand that if we don’t continually innovate and create products that respond to our customers’ ever-increasing demands, we will quickly become irrelevant (12:1)."

Howard Lackow, outsourcing practice manager at Reston, Virginia-based Transition Partners Co., defined innovation in business as "The merging worlds of technology, the convergence of cable, telephone, cellular, wireless, and e-business (12:1)." However, most would define innovation as conducting business in a completely new way. To better describe innovation, the following phrases show examples of innovation:.

Being the pioneer of ideas, services and products

First to do, others follow

Thinking beyond the traditional -- thinking outside the "container"

Outsourcing Assists Innovation

Innovation can take a company on its way out of business and transform it into one of the top companies in the industry. So how can a company create a breakthrough technology if its only focus is on maintaining the status quo? Most companies have answered that question by reaching out to outsourcing vendors to bring in technology and expertise to create opportunities for finding a breakthrough technology. By finding the right outsourcing vendor, a company can allow internal IS/IT developers to focus their efforts on the company’s core competencies and while exploiting outsourcing expertise who often bring in new ideas, procedures, and management strategies. The essential element is for both side to approach every opportunity jointly. Through innovation and continuous improvement, both the company and the outsourcing vendor are looking exploring how to improve daily operations and bring new technology to create a strategic advantage.

Virtually every industry has an example of innovation that was put in motion by the decision to outsource IS/IT functions. Some are even going so far as to outsource functions once thought to be the lifeblood of the company. Because of the complexity of technology and managing technology, companies are typically unprepared to manage it on their own. However, with a little guidance and direction from a vendor, companies can put themselves in focus, companies are in a better position to reallocate resources and move quickly in response to changing market indicators. Through outsourcing, companies typically gain expertise they never had before and become better equipped to look at requirements that will keep the company in business for the long-term.

Pitfalls in Pursuit of Innovation

Before a company loses total control of any process, senior managers must weigh the opportunities and the risks. Some of the key areas to consider are confidentiality, quality, relationship management, and legal and financial issues. According to outsourcing experts, one of the most common mistakes when attempting to build an outsourcing relationship is to treat the provider as a outsider and not as part of the internal team. Only through total involvement across the scope of the project can an outsourcing vendor provide its full experience and knowledge to the table.

A good example comes from an insurance company that created a new insurance plan, but after it was developed and approved for use, the company found that it was incompatible with the company’s existing technology. If the company had brought the technology personnel and outsourcing vendor into the problem at the beginning, they could have quickly identified a plan of action to avoid any future incompatibility. By understanding the problem, the outsourcer could have integrated the new system into the existing technology to ensure they were both ready at the same time.

Building a relationship is the most important step to successful innovation outsourcing. The biggest reason outsourcing projects fail has very little to do with technology and virtually everything to do with the people developing new innovations. "It is important to understand that companies are buying relationships, Frenza says. For example, if a company invests $800,000 on a Web site development project, the person across the table shouldn’t be viewed as an outsourcer as much as a business partner (12:1)."

Companies must ensure they cover other bases to ensure successful outsourcing support for ongoing and future innovations:

Legalities -- Cover your assets and protect the legal ownership of the innovation. Good fences around your property makes better relationships with business partners. For example, in Web development it is important to address issues such as who actually owns the Web site and the programming? Another aspect that must be address is what happens if the contract is terminated or if something goes wrong? Both sides need to have a common understanding so there are no surprises.

Return on Investment -- The company and outsourcing vendor must establish feasible targets for return on investment and then work jointly to achieve or even surpass those targets. If either side is not synchronized with the other, expectations by both will not be achieved and could result in a poor working relationship.

Project management -- Company must appoint internal project managers to work closely with external outsourcing vendors. Only be focusing both the internal unit and the vendor can the company hope to achieve its goals. Each vendor and company is different, so each project manager must look to bring out the strengths from both sides while simultaneously reducing the impact of any weaknesses.

Choosing Alliances Carefully

Companies need to identify the type of innovation and the organizational structure they will need to carry it out before they seek outside assistance. Each innovation opportunity is different and each company typically visualizes slight variations in how they will attack an opportunity. If the company wants to stay in control of the project, it needs to take the lead from the beginning and then keep both sides focuses until the project is completed.

With the expansion of Web development and e-commerce, companies are forced to create innovative new products to keep pace with the industry. Business models of the past have been overcome by events and companies must now create models that meet the digital age. Entrepreneurs are coming out of the woodwork as they attempt to capture a piece of the billion dollar e-business trade. Success stories such as amazon.com and e-bay are just the beginning of many success stories that will come from innovation and marketing, with innovation being the critical element to success in the generation of business transformation.

E-commerce has forced every company to rethink its business strategy to adapt to new markets and customer needs. As businesses work to improve their core business processes, corporate executives have been forced to rely on outsourcing to fill the daily operations and innovation gaps. According to Cambridge, Massachusetts-based research firm Forrester Research, technology has the opportunity to improve the innovation process by adding value in four ways (12:2):

Implementing technology that encourages innovation.

Identifying new ways to innovate through information.

Increasing efficiency through technology standardization.

Supporting innovation with project and portfolio management skills.

Managing Success

Innovation was never part of the original outsourcing model so business executives need to develop a new model that integrates innovation as one of the organization’s outsourcing objectives and recognize outsourcing as an integral part of the organization. Just as in previous outsourcing models, the innovation focus must be closely managed to ensure both sides have similar expectation and those expectations are being met. The difference in this model is that the relationship is ever more important as there must be continuous communication and sharing of ideas as projects are identified and designed. The person assigned to oversee these innovation projects will quickly become the company’s linchpin for maintaining good relations between the company and the vendor, ensuring projects meet target business objectives, and keeping activities on track to meet implementation deadlines.

Chief Information Officers (CIO) are rapidly becoming critical elements in any business and are gaining new ground in leadership roles on senior management teams. For any business to move forward in innovation, senior executives must be able to understand the action, opportunities, and risks associated with the project. That requires someone who not only understands the technology activities of the company, but who also is intimately aware of the core business processes. For a company to be successful, they must create hybrid managers who can bridge the gap to show executives the value of IS/IT investment and then use that technology to move the company to a new level in meeting corporate objectives.

Creating the Future

The only way to move forward is to create technology that either keeps or leapfrogs the company ahead of its competitors. In today’s fast business pace, most companies cannot simultaneously focus on day-to-day operations and building innovative ideas and products. Most companies have looked to outsourcing as a business partner in producing new ideas that will eventually result in innovative new products. No one can predict the future with 100 percent accuracy, but its almost a sure bet that outsourcing will continue to grow as companies expand their exploitation of new technology and management opportunities.

Next Generation Outsourcing

The internet is the single driving force behind all IS/IT products and services and has changed everything about the world as we know it. We can now communicate around the globe, buy and sell items 24 hours a day, learn about virtually any subject and the opportunities continue to expand as new ideas are incorporated into current technology. Along with transforming personal capabilities, the internet has completely changed the way companies compete and meet customer expectations. Businesses can no longer control business cycles because the internet has established its own set of rules for competition and drastically reduced barriers into regional, national, and even global markets. Virtual businesses are opening every day with a unique idea and limited operating capital.

According to outsourcing vendor IDC, the number of Internet users will grow from more than 140 million last year to more than half a billion users by the year 2003. IDC also estimates that e-commerce will explode from $50 billion last year to more than $1.3 trillion by 2003 (see figures 5 and 6). These trends show that e-commerce is much more than a passing business phase and therefore companies must adjust their business strategy to keep pace with shorter business cycles and more aggressive competitors.

Shift to Virtual

Some of the driving forces behind this shift to the virtual include a shortage of skilled workers, an expanding global economy, and significantly increased competition. To survive in this extremely fluid environment, companies need to quickly identify, design, and engineer new IS/IT products and services. Unfortunately, no single company can do this on its own and no single vendor can do it for them. The only way to compete is by creating a constantly shifting network of alliances and partnerships to achieve a dynamic set of corporate objectives. With the explosion of technology, outside vendors can see significant dollar amounts waiting if they are able to fill the gap brought on by the changing business environment. Because it often takes too long to develop technology in-house, vendors are often the answer.

In the past, it was common for companies to get bogged down in long negotiations for an IS/IT outsourcing contract. There was no real sense of urgency because the business cycle was much longer and basically determined by the individual businesses. That all changed with client/server technology and the introduction of the internet. Today, the business cycle is so short that lengthy negotiations will virtually guarantee the company will lose the business to a competitor who is quicker at getting products to market and meeting changing customer demands. The internet has changed the rules of business competition and forced companies in every industry to radically change their organizations to keep pace with extremely short, and getting even shorter, business cycles

In the 1960’s, the business cycle was 10 or 15 years long and the dominant information technology was the mainframe computer. Companies believed outsourcing could reduce costs by reducing personnel, reducing operating costs, and receiving cash in return for the outsourced assets. When the minicomputer was introduced in the 1980’s the business cycle had been cut in half as more and more companies could afford to purchase their own IS/IT technology.

By the 1990s, the PC had taken over the business world and introduced the era of client-server computing. This leap in technology immediately cut the business cycle to 1 to 3 years and presented numerous complex problems that did not exist under the mainframe or minicomputer eras. As companies struggled to optimize efficiency within their internal IS/IT organizations, they soon realized that they were fighting an uphill battle and recognized the value-added that outsourcing vendors could provide. E-business and e-ventures are now dominating the business world and business cycles are no longer measured in years or even months, rather they are measured by individual business transactions. If the company missed the initial opportunity, it was now even more important to recruit some help to catch up with the competition.

At one time companies had the luxury of dictating the pace of change, however, today, that pace is dictated by customer-driven markets. The internet has totally changed customer expectations regarding convenience, speed, comparability, price and service. The result is that companies must now meet those raised expectations quickly or be pushed aside by the competition. Any company in a competitive market that is not at every customer’s fingertips 24 hours a day is behind the competition and will likely fail to catch up. Through this fierce competition, outsourcers created numerous Web-based companies that are ready to compete in the nonstop internet economy and create innovative technology to become even more responsive to customer needs.

Outsourcing in the Future

As the pace of business speeds ahead, companies are looking for innovative methods for accessing information, entering new markets, gaining new sources of capital, and improving their manufacturing productivity. Survival is dependent on speed.

Companies face three big challenges: time to solution; time to market; and time to profit.

Outsourcing vendors are now posturing themselves to meet those future demands by giving customers access to new IS/IT capabilities and functionality to help them achieve their strategic goals quickly and with minimum risk. Outsourcing vendors can no longer concentrate on long-term contracts because the business cycle will no longer allow it. Vendors must be prepared to come into an organization ready to meet today’s challenges while simultaneously preparing the strategy and developing the tools to compete in future markets. Businesses need to find a way to go where they have never gone before, implement a more competitive business model, and operate in an environment where business cycles are a thing of the past.

Outsourcers need to provide capacity to overcome business obstacles and provide the expertise, technology, and resources that complement each client they serve as they determine their path of success. Through local, regional, and global support outsourcers provide total force that not only keeps pace with competitors, but also expands the markets within the global economy. As technologies evolve and new standards appear, outsourcers have to be prepared to meet every challenge and establish the standards for tomorrow.

Outsourcing Models

Outsourcing models and strategic intent of outsourcing (already covered in Strategic Intent for Outsourcing) are similar, but outsourcing models tends to focus more on the relationship between the vendor and the customer.

The first model is the single-source provider who typically provides all the services to meet a company’s IS/IT needs. The providers are usually very large business that often find it difficult to keep pace with current developments in computer and telecommunications technology. There is typically very little opportunity for innovation as the focus is on efficiency and meeting the terms of the contract. This model appears to be a carryover from the 1980’s as companies transitioned to the outsourcing era. This model will likely fade away as it fails to keep pace with today’s dynamic business environment.

The best-in-breed model allows the business to contract separately with the best vendors in their field and then manages the entire process in-house. This model provides many advantages because the customer has the best technology and services to meet current and future business objectives. The down side is that is often very difficult to manage and often has significant associated costs. The client assumes the prime contractor role and must use internal personnel to manage multiple contacts. The situation typically ends up with limited numbers of internal personnel assuming greater responsibility for something they little or no experience managing. Without a focused management team, this strategy can often increase the risk of failure.

The third model is prime contracting with a best-in-breed scenario, but one of the outsourcers actually manages the other external service providers and becomes the single point of accountability for the customer. This model is power-based and event-driven as the prime contractor oversees the work of all subcontractors and has all the authority to direct them as required. Although companies can get the get some of the best outsourcers available, most will not consider this arrangement as a long-term relationship. The contracting business is extremely competitive and it would be extremely difficult to equally balance all subcontractors. There is potential for short-term gains, but the customers support will suffer in the long-term.

There is now a fourth model emerging called the consortium model. This model is believed to be best suited to meet the growing needs of customers in a Web-based business environment. The consortium model combines the best-in-breed and prime contracting model, but instead of a contractor-subcontractor relationship, the relationship between vendors is that of partners. Using this approach levels the playing field and puts every organization in a win-win situation. Vendors work as full partners and are better able to leverage their unique capabilities to better the entire organization. This approach has many advantages as it reduces the level of risk while addressing both short-term and long-term objectives of the company.

Leadership roles under the consortium model can shift back and forth, depending on the nature of the products and services being offered. Partners may involve any combination of competitors, large and small, but they are all working together to benefit the customers. As the customer faces new market conditions, the outsourcing partners can quickly move to jointly realign personnel and resources to achieve any new objectives. The primary focus is to place vendors in a position where each organization benefits as they improve the customer’s ability to meet every market challenge.