When outsourcing works both ways

Businesses in the UK outsource hundreds of billions of pounds’ worth of services every year, from refuse collection to core software testing. Outsourcing of information technology (IT), however, creates a dilemma for many companies because it is both a cost-cutting opportunity and a critical business enabler.

Companies, from large corporates to small and medium-sized enterprises, are reducing their capital expenditure by running internal processes on third-party IT infrastructure. Businesses are saving money by having IT work carried out in low-cost offshore regions and are accessing IT skills on demand, with software applications being created, managed and maintained by a supplier.

Gartner, the global technology analyst, predicts £160bn will be invested in IT services in 2012, a 2.1 per cent increase on last year. Data centres, applications and infrastructure are the three most common IT functions to be outsourced.

Handing over some control of a computer system to a third party is a difficult decision, but the appeal is strong. The evolutionary nature of IT means businesses constantly need to invest in new technologies and the skills to support them. Lowering these costs is usually the main reason for outsourcing.

Peter Brudenall, a London-based outsourcing lawyer at Lawrence Graham, says: “It makes sense to outsource business processes or IT when it is clear someone else can do the job more efficiently, and for the same or lower cost, than you can.”

Recent research by KPMG, the consultancy, revealed that, when asked for the reasons for outsourcing in 2012, 70 per cent of business decision makers said cost was a driver. This is high but decreasing: in the same survey in 2010, 83 per cent of respondents said cost was a reason to outsource IT.

The survey revealed other factors that are becoming increasingly important: access to skills (51 per cent), quality improvements (48 per cent) and a way to transform the business (21 per cent) all increased in importance in 2012 compared with the previous study.

Lee Ayling, a partner in KPMG’s outsourcing division, says financial flexibility and the ability to get to market with new products are other drivers of outsourcing. He says deciding when to outsource is critical and depends on where the business is in its life cycle. Second- and third-generation outsourcing focuses more on access to skills and quality improvement after cost savings have been made in initial outsourcing, he adds.

Ilan Oshri, professor of technology and globalisation at Loughborough University School of Business and Economics, says cost is still the main driver but warns businesses to ask themselves: at what price? The business might lower the investment needed to provide a service, but there could be hidden costs, such as customer dissatisfaction as a result of poor services from the supplier.

He says companies today outsource business processes that only five years ago were considered to be competitive advantages, such as business analytics or supply chain management in retail.

This broadening of outsourcing from functions such as call centres to more critical services makes it more difficult to reverse the decision. Unlike changing an office maintenance company, for example, bringing IT work back in-house is akin to a reverse lobotomy.

“Once a decision to outsource is made, there is no going back without considerable pain, risk and investment to bring it back in house,” says Robert Morgan, director at Burnt Oak Partners, a London-based outsourcing consultancy.

There is, however, a trend of reversing outsourcing, says Prof Oshri.

General Motors (GM) is a good example. The company is recruiting thousands of IT professionals so that it can reduce the amount of work it outsources. About 90 per cent of its IT is carried out by suppliers and 10 per cent in house, but GM wants to reverse this ratio.

The rationale behind the decision is to consolidate its IT, by offloading multiple outsourcing contracts, to become more efficient and to allow it to focus on IT innovation and thereby increase competitiveness.

GM is a company with a pioneering history in IT outsourcing, and its management has a particularly strong understanding of the concept. In 1984, GM it acquired IT services firm EDS, which became its internal IT department. Just over a decade later, GM spun off EDS as an independent company but remained a big customer. In 2008, HP acquired EDS and took over a large outsourcing contract with GM that looks set to end in the next few years.

The outsourcing of IT has also arrived at a watershed with the increasing take-up of cloud-based services. Google Apps for Business and Amazon Web Services, for example, though only accounting for £3.2bn of the total £160bn IT outsourcing sector, form part of the fastest-growing segment, according to Gartner’s research.

The cloud, which is a form of outsourcing where many companies share resources on demand, will soon become a dilemma for business. The lower costs, flexibility and ability to change suppliers is attractive compared with fixed-term, fixed-cost outsourcing contracts.

Karl Flinders is services editor at Computer Weekly