2010‐10‐06
TDDD31 Software Engineering with International Partners
Lecture 4
Outsourcing Risk Management
Peter Bunus
Department of Computer and Information Science, Linköping University Sweden
peter.bunus@liu.se
What has been discussed during the lectures?
 IT outsourcing versus inhouse development and operations
– IT outsourcing relies on external parties to provide development and/or infrastructure operations support (e.g. Campbell's outsourcing to IBM; Dow's outsourcing to Accenture and IBM)
g
)
– Inhouse sourcing requires technical expertise to develop and runsystems
 Business process outsourcing vs. inhouse business processes
– Business process outsourcing relies on external parties to process transactions associated with business functions (e.g. Qatar Airways outsources revenue accounting; BAE Systems outsources HR)
– Traditionally, firms have created functions to run all essential functions, whether or not they are strategic.
h th
t th
t t i
 Onshore versus offshore outsourcing
– Offshore outsourcing provides variable capacity and usually results in lower wages – –Onshore outsourcing provides proximity and avoids time zone issues
Source: Center for Information Systems Research (CISR) © 2009 MIT Sloan CISR ‐ Ross 2
1
2010‐10‐06
What has been discussed during the lectures?
 Dedicated processing versus "the cloud"
–Most firms install their software, then take responsibility for running their systems, which includes installing upgrades and enhancements.
–Salesforce.com, IBM, Oracle and others are offering to provide software as a service (SaaS), which means they will run the software on their machinesand take care of all updates and maintenance. Source: Center for Information Systems Research (CISR) © 2009 MIT Sloan CISR ‐ Ross 3
IT and Business Process Outsourcing: Promises and RisksIT Risks
 Beware of the expected cost savings from outsourcing.  IT outsourcing changes the skill requirements of the IT unit.
 Some processes within a firm are commodities and those processes can—and
processes can
and often should
often should—be
be outsourced for operational outsourced for operational
excellence. (But wait for the market to materialize.)
 A strategy of operational excellence can inhibit rather than promote business innovation.  Some business processes are distinctive. For those, outsourcing is risky.
 Outsourcing can accelerate architecture maturity. Architecture g
y
maturity can better position a firm to benefit from outsourcing.
 Offshoring and “cloud”technologies have promise but they do not resolve problems caused by undisciplined business processes. They demand new management skills.
Source: Center for Information Systems Research (CISR) © 2009 MIT Sloan CISR ‐ Ross 4
2
2010‐10‐06
Risk Management
5
What is Risk?
 Risk as an undesirable event. According to Levine and Schneider (1997, pg. 38), risk is “…events that, if they occur, represent a material threat to an entity’s fortune.” Using this approach, risk can be interpreted as an occurrence of undesirable events
can be interpreted as an occurrence of undesirable events.
– Risk as a probability function
– Risk as a variance: In finance, risk is calculated as the variance of the distribution of outcomes
– Risk as expected loss: In some disciplines such as casualty insurance, risk is interpreted as expected loss, which is the product of a loss function and a probability function
6
3
2010‐10‐06
Expected Return
 The expected rate of return on a stock represents the mean of a probability distribution of possible future returns on the stock. The table below provides a probability distribution for the returns on stocks A and B
 In this probability distribution, there are four possible states of the world one period into the future. For example, state 1 may correspond to a recession. A probability is assigned to each state. The probability reflects how likely it is that the state will occur. The sum of the probabilities must equal 100%, indicating that something must happen. The last two columns present the returns or outcomes for stocks A and B that will occur in the four states. 7
Calculate the Expected Return
8
4
2010‐10‐06
Measure of Risk – Variance  Given an asset's expected return, its variance can be calculated using the following equation:
 The standard deviation is calculated as the positive square root of the variance. 9
Calculate the Variance and the SD
Although Stock B
Alth
h St k B offers a higher ff
hi h
expected return than Stock A, it also is riskier since its variance and standard deviation are greater than Stock A's
10
5
2010‐10‐06
Risk Classification
• Transition costs ‐ cost of switching service providers (e.g. internal to external)
• Contractual amendments ‐ flexibility in updating contract for business changes
• Cost escalation ‐ risk of opportunistic price hikes by service provider
• Management costs ‐ cost of monitoring and supervising the outsourcing operation
• Disputes and litigations ‐ risk of legal complications
• Loss of organizational competencies – risk of tacit knowledge loss
• Lock‐in ‐ risk of captive contract by monopolist service provider
• Service debasement ‐ risk of performance degradation in service provision
11
IT Outsourcing Risks
12
6
2010‐10‐06
Risks
 Lock‐in
–
–
–
–
–
Asset specificity
Small number of suppliers
Client’ss degree of expertise in outsourcing contracts
Client
degree of expertise in outsourcing contracts
Inability to adapt the contract to changing business and technology
Inflexible contracting
 Hidden/excess cost
–
–
–
–
–
–
Uncertainty Opportunism
Client’ss degree of expertise in IT operations
Client
degree of expertise in IT operations
Client’s degree of expertise in outsourcing contracts
Relatedness
Fixed process that exceed market prices two to three years into the contract
13
Risks
 Costly contractual amendments
– Uncertainty – Technological discontinuity
 Disputes and litigations
Disp tes and litigations
–
–
–
–
Measurement problems
Client’s lack of experience in managing outsourcing project
Supplier’s degree of expertise in IT operations
Supplier’s degree of expertise in IT contracting
 Service debasement
– Failure to retain requisite capabilities and skills
F il
t
t i
i it
biliti
d kill
– Lack of innovation from supplier – Deteriorating service in the face of patchy supplier staffing of the contrac
14
7
2010‐10‐06
Risks
 Cultural differences
–
–
–
–
–
–
–
–
–
Unclear responsibilities
No interaction among cross‐cultural team members
Conflicting development standards
Conflicting development standards
Widely divergent working styles
Mistrust and miscommunications
Poorly articulated requirements
Inability to resolve time zone differences
Poor communication of decision
Unwillingness to provide feedback
g
p
15
8