An Introduction to the Outsourcing
and Offshoring Landscape
Origins of Outsourcing
Roman Empire (approx. 150 B.C.)
Tax farmers (Publicani) were used to collect taxes
from the provincials. Rome, in eliminating its own
burden for this process, would put the collection of
taxes up for auction every few years. The Publicani
would bid for the right to collect in particular regions,
and pay the state in advance of this collection. These
payments were, in effect, loans to the state and Rome
was required to pay interest back to the Publicani. As
an offset, the Publicani had the individual
responsibility of converting properties and goods
collected into coinage, alleviating this hardship from
the treasury. In the end, the collectors would keep
anything in excess of what they bid plus the interest
due from the treasury; with the risk being that they
might not collect as much as they originally bid.
Origins of Outsourcing
Early American History
The production
of wagon
covers
Was
outsourced to
Scottish
Manufacturers
Who used raw
material
imported from
India
Origins of Outsourcing
Manufacturing Organizations
• Outsourcing remained popular in manufacturing with part of
the assembling being subcontracted to other organizations
and locations where the work could be done more efficiently
and cheaply
• Pastin and Harrison (1974) wrote that such outsourcing was creating a new
form of organization which the termed the “Hollow Corporation”
(An organization that designs and distributes, but does not produce anything)
• Now: Virtual Organizations
The world’s largest supplier of
telecommunications product; manufacturer
of none
Origins of Outsourcing
IS/IT Outsourcing
• In the early 1960’s Electronic Data Systems (EDS) in
Dallas, Texas, approached large corporations to get them
to outsource their data processing services. for his data
processing services.
• Perot was refused 77 times before he got his first contract
• EDS received lucrative contracts from the U.S. government in 1963,
computerizing Medicare records.
• EDS went public in 1968 and the stock price shot up from $16 a share to
$160 within days.
• In 1984 General Motors bought controlling interest in EDS for $2.4 billion.
Origins of Outsourcing
IS/IT Outsourcing
• On Oct 2, 1989, Eastman Kodak announced that it was
outsourcing its information systems (IS) function 1989 to
IBM (IBM Global Services' first customer)
• That year, the head of IT at KODAK was named information
chief of the year by CIO Magazine.
Katherine M. Hudson
• Eastman Kodak’s decision to outsource the information technology systems that
undergird its business was considered revolutionary in 1989, but it was actually
the result of rethinking what their business was about.
• "She led Kodak to what was a counterintuitive move for the time: She showed that
running data centers was no more a core competency of Kodak's than running a
power plant would be," says F. Warren McFarlan, senior associate dean and
professor in the Advanced Management Program at the Harvard Business School.
• While Kodak signed on with IBM to outsource its mainframe data management,
Kodak chose to outsource the provisioning of its PC purchases to desktop
systems-integration firm Businessland Inc. and its network operations to Digital
Equipment Corp.
• IBM has since taken over Digital's role and now provides direct PC sales to
Kodak as well.
Outsourcing Today (These figures are dated)
• 2003: $178 Billion
• 2007: $235 Billion
• 2008: $261 Billion
• IT outsourcing is estimated to be 67% of all outsourcing deals
Basic Terminology
• Outsourcing:
• Delegation of non-core operations from internal production to an external entity.
Sharing organizational control.
• Offshoring:
• Transferring Activities to another country by hiring local subcontractors or by building a
facility in an area where labor is cheap(er).
The globalization of outsourcing operating models has resulted in new terms
• Nearsourcing:
• Offshore to a nearby country where language and cultural differences are smaller
• Rightsourcing:
• Restructuring a company's workforce to find the optimum mix of jobs performed
locally and jobs moved to foreign countries
Related terms
• Insourcing:
• Keeping Operations in-house
• Backsourcing:
• Returning outsourced operation to in-house operations
• Best Sourcing:
• Associating with the ‘best of the best’ (Tom Peters)
• Multisourcing:
• large outsourcing agreements
Outsourcing is ….
 A free market thing
 A Special form of international trade (CES IFO Institute








,Germany)
A matter of polarized public debate (European Foundation
for ILWC,2004)
About your “core”
A question of trust
Unevenly dispersed on the globe (yet growing)
Generating fear (fear of change?- Cochrane,2004)
A relationship and arrangement
Partner quality
Subject to areas of high attrition ? (ex-Call centers)
Reasons for Outsourcing
Every Morning in Africa, a gazelle wakes up.
It knows it must run faster than the fastest lion
or it will be killed.
Every morning a lion wakes up.
It knows it must outrun the slowest gazelle
or it will starve to death.
It doesn’t matter whether you are a lion or a gazelle
When the sun comes up,
YOU BETTER START RUNNING!
African Proverb
Reasons for Outsourcing*
• Cost savings. The lowering of the overall cost of the service to the business. This will
involve reducing the scope, defining quality levels, re-pricing, re-negotiation, cost restructuring. Access to lower cost economies through offshoring called "labor arbitrage"
generated by the wage gap between industrialized and developing nations.
• Focus on Core Business. Resources (e.g., investment, people, infrastructure) are
focused on developing the core business. For example often organizations outsource their
IT support to specialized IT services companies.
• Cost restructuring. Operating leverage is a measure that compares fixed costs to variable
costs. Outsourcing changes the balance of this ratio by offering a move from fixed to
variable cost and also by making variable costs more predictable.
• Improve quality. Achieve a step change in quality through contracting out the service with
a new service level agreement.
• Knowledge. Access to intellectual property and wider experience and knowledge.
• Contract. Services will be provided to a legally binding contract with financial penalties and
legal redress. This is not the case with internal services
• Operational expertise. Access to operational best practice that would be too difficult or
time consuming to develop in-house.
* Some of this is taken from Wikipedia – NOT necessarily reliable
Reasons for Outsourcing*
• Capacity management. An improved method of capacity management of services and
technology where the risk in providing the excess capacity is borne by the supplier.
• Catalyst for change. An organization can use an outsourcing agreement as a catalyst for
major step change that can not be achieved alone. The outsourcer becomes a Change
agent in the process.
• Enhance capacity for innovation. Companies increasingly use external knowledge
service providers to supplement limited in-house capacity for product innovation
• Reduce time to market. The acceleration of the development or production of a product
through the additional capability brought by the supplier.
• Commodification. The trend of standardizing business processes, IT Services, and
application services which enable to buy at the right price, allows businesses access to
services which were only available to large corporations
• Operational expertise. Access to operational best practice that would be too difficult or
time consuming to develop in-house.
Reasons for Outsourcing*
• Risk management. An approach to risk management for some types of risks is to partner
with an outsourcer who is better able to provide the mitigation
• Venture Capital. Some countries match government funds venture capital with private
venture capital for startups that start businesses in their country.
• Tax Benefit. Countries offer tax incentives to move manufacturing operations to counter
high corporate taxes within another country.
• Scalability. The outsourced company will usually be prepared to manage a temporary or
permanent increase or decrease in production.
• Access to talent. Access to a larger talent pool and a sustainable source of skills, in
particular in science and engineering.
• India has over 2,100,000 English-speaking graduates added annually and
460,000 of them are IT grads.
• China has over 200,000 IT professionals and 50,000 new graduates are
added to the pool every year.
• China produces 52% of all Science and Engineering graduates
• Work Attitudes “In China today, Bill Gates is Britney Spears.
In America today, Britney Spears is Britney Spears
and that is our problem.”
Thomas Friedman
Criticisms of outsourcing
Loss of Jobs
• A University of California Study that estimates 14 million
U.S. white collar jobs - one in nine - are at risk.
• A 2004 report by Forrester Research suggests that a total of
3.4 million U.S. white collar jobs will move overseas by
2015, with 830,000 jobs leaving by the end of 2005.
• A Progressive Policy Institute report claims 12 million jobs
are vulnerable, with most paying more than the U.S. median
wage.
Criticisms of outsourcing
Loss of Control
• "I've had people approach me and offer to save us money by
consolidating our technical support," said Monad.net President George
Scott. "But I think technical support is a major competitive advantage. I
therefore want control of that -- I don't want to give it away."
• "Everyone knows that differentiation is the key in the ISP business, and
this also goes for dealing with the pressures of handling technical
support," said the operations manager of a Massachusetts ISP. "No ISP is
happy with the fact that they have to handle so many calls from
customers who are not adept with their PCs, but we understand that
handing them over to a third party is the wrong business move."
Criticisms of outsourcing *
Quality Risks
• Quality Risk is the propensity for a product or service to be defective, due to operationsrelated issues. Quality risk in outsourcing is driven by a list of factors. One such factor is
opportunism by suppliers due to misaligned incentives between buyer and supplier,
information asymmetry, high asset specificity, or high supplier switching costs. Other factors
contributing to quality risk in outsourcing are poor buyer-supplier communication, lack of
supplier capabilities/resources/capacity, or buyer-supplier contract enforceability.
Quality of service
• Quality of service is measured through a service level agreement (SLA) in the outsourcing
contract. In poorly defined contracts there is no measure of quality or SLA defined. Even
when an SLA exists it may not be to the same level as previously enjoyed. This may be due
to the process of implementing proper objective measurement and reporting which is being
done for the first time. It may also be lower quality through design to match the lower price.
There are a number of stakeholders who are affected and there is no single view of quality.
The CEO may view the lower quality acceptable to meet the business needs at the right
price. The retained management team may view quality as slipping compared to what they
previously achieved. The end consumer of the service may also receive a change in service
that is within agreed SLAs but is still perceived as inadequate. The supplier may view
quality in purely meeting the defined SLAs regardless of perception or ability to do better.
Criticisms of outsourcing *
Language skills
• In the area of call centers end-user-experience is deemed to be of lower quality when a
service is outsourced. This is exacerbated when outsourcing is combined with off-shoring to
regions where the first language and culture are different. In addition to language and
accent differences, a lack of local social and geographic knowledge is often present, leading
to misunderstandings or miscommunications
Public opinion
• There is a strong public opinion regarding outsourcing (especially when combined with
offshoring) that outsourcing damages a local labor market. Outsourcing is the transfer of the
delivery of services which affects both jobs and individuals. It is difficult to dispute that
outsourcing has a detrimental effect on individuals who face job disruption and employment
insecurity; however, its supporters believe that outsourcing should bring down prices,
providing greater economic benefit to all. There are legal protections in the European Union
regulations called the Transfer of Undertakings (Protection of Employment). Labor laws in
the United States are not as protective as those in the European Union.
Staff turnover
• The staff turnover of employee who originally transferred to the outsourcer is a concern for
many companies. Turnover is higher under an outsourcer and key company skills may be
lost with retention outside of the control of the company. In outsourcing offshore there is an
issue of staff turnover in the outsourcer companies call centers. It is quite normal for such
companies to replace its entire workforce each year in a call center. This inhibits the buildup of employee knowledge and keeps quality at a low level.
Criticisms of outsourcing *
Social responsibility
• Outsourcing sends jobs to the lower-income areas where work is being outsourced to,
which provides jobs in these areas and has a net equalizing effect on the overall distribution
of wealth. Some argue that the outsourcing of jobs (particularly off-shore) exploits the lower
paid workers. A contrary view is that more people are employed and benefit from paid work.
Despite this argument, domestic workers displaced by such equalization are proportionately
unable to outsource their own costs of housing, food and transportation.
• On the issue of high-skilled labor, such as computer programming, some argue that it is
unfair to both the local and off-shore programmers to outsource the work simply because
the foreign pay rate is lower. On the other hand, one can argue that paying the higher-rate
for local programmers is wasteful, or charity, or simply overpayment. If the end goal of
buyers is to pay less for what they buy, and for sellers it is to get a higher price for what they
sell, there is nothing automatically unethical about choosing the cheaper of two products,
services, or employees.
• Social responsibility is also reflected in the costs of benefits provided to workers.
Companies outsourcing jobs effectively transfer the cost of retirement and medical benefits
to the countries where the services are outsourced. This represents a significant reduction
in total cost of labor for the outsourcing company. A side effect of this trend is the reduction
in salaries and benefits at home in the occupations most directly impacted by outsourcing.
Criticisms of outsourcing *
Company knowledge
• Outsourcing could lead to communication problems with transferred employees. For
example, before transfer staff have access to broadcast company e-mail informing them of
new products, procedures etc. Once in the outsourcing organization the same access may
not be available. Also to reduce costs, some outsource employees may not have access to
e-mail, but any information which is new is delivered in team meetings.
Qualifications of outsourcers
• The outsourcer may replace staff with less qualified people or with people with different nonequivalent qualifications. In the engineering discipline there has been a debate about the
number of engineers being produced by the major economies of the United States, India
and China. The argument centers around the definition of an engineering graduate and also
disputed numbers. The closest comparable numbers of annual graduates of four-year
degrees are United States (137,437) India (112,000) and China (351,537)
Failure to deliver business transformation
• Business transformation promised by outsourcing suppliers often fails to materialize. In a
commoditised market where many service providers can offer savings of time and money,
smart vendors have promised a second wave of benefits that will improve the client’s
business outcomes. According to Vinay Couto of Booz & Company “Clients always use the
service provider’s ability to achieve transformation as a key selection criterion. It’s always in
the top three and sometimes number one.” While failure is sometimes attributed to vendors
overstating their capabilities, Couto points out that clients are sometimes unwilling to invest
in transformation once an outsourcing contract is in place
Criticisms of outsourcing *
Productivity
• Offshore outsourcing for the purpose of saving cost can often have a negative influence on
the real productivity of a company. Rather than investing in technology to improve
productivity, companies gain non-real productivity by hiring fewer people locally and
outsourcing work to less productive facilities offshore that appear to be more productive
simply because the workers are paid less. Sometimes, this can lead to strange
contradictions where workers in a developing country using hand tools can appear to be
more productive than a U.S. worker using advanced computer controlled machine tools,
simply because their salary appears to be less in terms of U.S. dollars. In contrast,
increases in real productivity are the result of more productive tools or methods of operating
that make it possible for a worker to do more work. Non-real productivity gains are the result
of shifting work to lower paid workers, often without regards to real productivity. The net
result of choosing non-real over real productivity gain is that the company falls behind and
obsoletes itself overtime rather than making investments in real productivity.
Security
• Before outsourcing an organization is responsible for the actions of all their staff and liable
for their actions. When these same people are transferred to an outsourcer they may not
change desk but their legal status has changed. They no-longer are directly employed or
responsible to the organization. This causes legal, security and compliance issues that need
to be addressed through the contract between the client and the suppliers. This is one of
the most complex areas of outsourcing and requires a specialist third party adviser.
Criticisms of outsourcing *
Security (continued)
• Fraud is a specific security issue that is criminal activity whether it is by employees or the
supplier staff. However, it can be disputed that the fraud is more likely when outsourcers are
involved, for example credit card theft when there is scope for fraud by credit card cloning.
In April 2005, a high-profile case involving the theft of $350,000 from four Citibank
customers occurred when call center workers acquired the passwords to customer accounts
and transferred the money to their own accounts opened under fictitious names. Citibank
did not find out about the problem until the American customers noticed discrepancies with
their accounts and notified the bank.
Standpoint of labor
• From the standpoint of labor within countries on the negative end of outsourcing this may
represent a new threat, contributing to rampant worker insecurity, and reflective of the
general process of globalization. While the "outsourcing" process may provide benefits to
less developed countries or global society as a whole, in some form and to some degree include rising wages or increasing standards of living - these benefits are not secure.
Further, the term outsourcing is also used to describe a process by which an internal
department, equipment as well as personnel, is sold to a service provider, who may retain
the workforce on worse conditions or discharge them in the short term. The affected
workers thus often feel they are being "sold down the river."
Criticisms of outsourcing
Hidden Costs
• The Cost of Managing an Offshore Contract
• "There's a significant amount of work in invoicing, in
auditing, in ensuring cost centers are charged correctly, in
making sure time is properly recorded," explains DHL's Kifer.
"We have as many as 100 projects a year, all with an offshore
component, so you can imagine the number of invoices and
time sheets that have to be audited on any given day."
• We knew there would be invoicing and auditing," he says.
"But we didn't fully appreciate the due diligence and time it
would require."
• Bottom line: Expect to pay an additional 6 percent to 10
percent on managing your offshore contract
Criticisms of outsourcing
Hidden Costs
• The Cost of Managing an Offshore Contract
• "There's a significant amount of work in invoicing, in
auditing, in ensuring cost centers are charged correctly, in
making sure time is properly recorded," explains DHL's Kifer.
"We have as many as 100 projects a year, all with an offshore
component, so you can imagine the number of invoices and
time sheets that have to be audited on any given day."
• We knew there would be invoicing and auditing," he says.
"But we didn't fully appreciate the due diligence and time it
would require."
• Bottom line: Expect to pay an additional 6 percent to 10
percent on managing your offshore contract
Criticisms of outsourcing
Hidden Costs
• The Cost of Selecting a Vendor
• “With any outsourced service, the expense of selecting a service
provider can cost from .2 percent to 2 percent in addition to the
annual cost of the deal. In other words, if you're sending $10 million
worth of work to India, selecting a vendor could cost you anywhere
from $20,000 to $200,000 each year”.
• “Some companies hire an outsourcing adviser for about the same cost
as doing it themselves. To top it off, the entire process can take from
six months to a year, depending on the nature of the relationship”.
• “Bottom line: Expect to spend an additional 1 percent to 10 percent
on vendor selection and initial travel costs”.
•
Source: The Hidden Costs of Offshore Outsourcing. Sep. 1, 2003 Issue of CIO Magazine
Criticisms of outsourcing
Hidden Costs
• The Cost of Transition
• “The transition period is perhaps the most expensive stage of an
offshore endeavor. It takes from three months to a full year to
completely hand the work over to an offshore partner. If company
executives aren't aware that there will be no savings—but rather
significant expenses—during this period, they are in for a nasty
surprise.”.
• “It took an awful lot of time to bridge the Pacific and getting that to
work correctly," remembers Textron Financial's Raspallo, who spent
six months and $100,000 to set up a transoceanic data line with Infosys
in 1998, It also cost an extra $10,000 a month to keep that network
functional.”.
• Bottom Line: Expect to spend an additional 2 percent to 3 percent on
transition costs”.
•
Source: The Hidden Costs of Offshore Outsourcing. Sep. 1, 2003 Issue of CIO Magazine
Criticisms of outsourcing
Hidden Costs
• The Cost of Layoffs
• “To begin with, you have to pay workers severance and retention
bonuses. You need to keep employees there long enough to share their
knowledge with their Indian replacements. People think if they give
generous retention bonuses it will destroy the business proposition.
They cut corners because they want quick payback. But then they lose
the people that can help with the transition and incur the even bigger
cost of not doing the transition right.".”.
• Bottom line: Expect to pay an extra 3 percent to 5 percent on layoffs
and related costs.
•
Source: The Hidden Costs of Offshore Outsourcing. Sep. 1, 2003 Issue of CIO Magazine
Criticisms of outsourcing
Hidden Costs
• The Cultural Cost
• “You simply cannot take a person sitting here in America and replace
them with one offshore worker," GE Real Estate's Zupnick says.
"Whether they're in India or Ireland or Israel”
• “a project that's common sense for a U.S. worker—like creating an
automation system for consumer credit cards—may be a foreign
concept offshore.”
• Bottom line: Expect to spend an extra 3 percent to 27 percent on
productivity lags.
•
Source: The Hidden Costs of Offshore Outsourcing. Sep. 1, 2003 Issue of CIO Magazine
Critical areas for a successful outsourcing program
• Understanding company goals and objectives
• A strategic vision and plan
• Selecting the right vendor
•
•
•
•
•
•
Ongoing management of the relationships
A properly structured contract
Open communication with affected individual/groups
Senior executive support and involvement
Careful attention to personnel issues
Short-term financial justification
The Pre-Outsourcing Process
Program Initiation
• At the start of any outsourcing program, there are a variety of ideas and opinions about the
purpose and scope of the program, what the final result of the program will be, and how the
program will be carried out. The Program Initiation Stage is concerned with taking these
ideas and intentions and documenting them to form the basis of a draft contract.
Service Implementation
• Service Implementation covers the activities required to take these ideas and intentions and
develop them into a formal, planned outsourcing program and to make the transition to the
outsourced service.
• Specifically these activities are:
•
•
•
•
•
•
Defining the transition project
Transferring staff
Defining the Service Level Agreement (SLA)
Defining service reporting
Implementing and handing over the service
Implementing service management procedures
• During the hand–over phase it is imperative that continuity of service is maintained at all
times, that there is no reduction in the quality of the delivery and that timescales and
deadlines are not compromised.
The Pre-Outsourcing Process
Final Agreement
• The draft contract produced at the Initiation stage is generally amended during negotiations
and the final Contract is produced on completion of the negotiation cycle.
Program Closure
• In order to gain maximum benefit, the program should go through a formal close down.
There is no point in continuing to argue lost causes once irrevocable decisions have been
taken. Staff and companies alike need to accept the new situation and move forward.
However, there will be a lot of information generated during the life of the program, and this
will have been stored with varying degrees of formality by the team members. This
information needs to be formally filed away for future reference.
Types of Sourcing Arrangements
• There are four fundamental parameters that determine the kind of outsourcing
arrangement that a firm may enter into: degree (total, selective, and none);
mode (single vendor/client or multiple vendors/clients); ownership (totally
owned by the company, partially owned, externally owned); and time frame
(short term or long term). The combination of specific instances of these
parameters yields different types of sourcing arrangements such as joint
ventures, facilities sharing, and spin-offs.
Degree of
Outsourcing
Total
Selective
None
Internal
Ownership
Partial
Spin-offs
(Wholly Owned
Subsidiary)
Joint
Venture
Insourcing /
Backsourcing
Facilities Sharing among
multiple clients
External
Traditional
Outsourcing
Selective
Outsourcing
N/A
* Dibbern, J. and Goles, T. and Hirschheim, R. and Jayatilaka, B. (2004) "Information Systems Outsourcing: A Survey and
Analysis of the Literature“ In: The DATA BASE for Advances in Information Systems, Volume 34, Issue Number 4, pp 6-102
Stage model of IS outsourcing
Simon’s Decision
Making Model
Intelligence
Outsourcing Stages
• Determinants
• Advantages/Disadvantages
Why
What
Choice
Which
Implementation
Outcome
Phase 2:
Implementation
How
Phase 1:
Decision Process
Design
Application of Outsourcing
Stages
Outsourcing Alternatives:
• Degree of Ownership
• Degree of Outsourcing
Guidelines, Procedures,
stakeholders of decision initiation,
Evaluation
• Vendor Selection
• Relationship buildings
• Relationship Management
• Experiences/Learning
• Types of Success
• Determinants of Success
Course Organization
Basic IT Outsourcing Life Cycle
Global Challenges
Outsourcing
Decision
Determinant
Application
Service Providing
(ASP) and
Business Process
Outsourcing
(BSO)
Outsourcing
Experiences and
Outcomes
Outsourcing
Relationships:
Arrangement and
Management
Offshoring and
Global
Outsourcing
Perspectives
Individual View
Vendor View