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Outsourcing and contracting out of IT products and services

v1.1 issued 6 August 1997

Authorised by Tom Worthington MACS, President of the Australian Computer Society

Contents

Introduction

 The primary aim of this paper * is to provide advice to members concerning the contracting out of IT services.

This has become important particularly, but not exclusively, because of the current high level of interest in the government outsourcing of IT by federal and state government agencies in Australia.

A secondary purpose is to make such a paper available as a part of a submission to the Senate Finance and Public Administration References Committee for its IT Outsourcing inquiry.

6 August 1997

* This paper has been prepared by Ian Dennis, FACS and David Goble, MACS, both of Whitehorse Strategic Group Ltd, and draws upon previous material developed by the Out-Right task-force, including Dr. John Houghton and Dr. Ed Lewis. The initial brief and final editing was provided by Tom Worthington, MACS, with additional input from others.

Definition of Outsourcing

It is important to be clear about what is meant by outsourcing. Outsourcing has become a commonly misused term, and much of the apparent disagreement over the merits and risks of outsourcing can be traced to differing definitions.

Outsourcing is essentially a how rather than a what term. It describes how IT services are obtained; not what the services are. (1)

Outsourcing has been defined as:

"A contractual relationship where an external organisation takes responsibility for performing all or part of an agency's Information Technology functions. This can involve a partial or complete transfer of staff and/or resources."
(2)

This definition is in the context of public sector agencies, but could be equally applied to company outsorcing.

Outsourcing is:

"An arrangement whereby a third party provider assumes responsibility for performing information systems functions at a pre-determined price and according to predetermined performance criteria."
(3)

These definitional statements highlight the features that are the essential aspects of outsourcing, namely:

In a sense outsourcing is just a name for old practices. Services such as, bureau services, contract programming and project management have long been `outsourced'. In its present usage, however, outsourcing implies a greater level of handing over ownership and/or managerial control than has hitherto been the case. (4)

Thus:

ACS members working as contractors under the day to day supervision of the organisation, are in a different position to those brought in by an outsourcing supplier.

Reasons For Outsourcing (Refs. 9)

There are many factors involved in the outsourcing equation, and the importance given to them will depend on the circumstances of each case.

Cost Savings

Outsourcing can reduce both fixed and recurrent costs.

Outsourcing vendors should be in a position to reap economies of scale that may not be available to the client alone. The vendor can save on IT hardware and software costs through consolidation of operations and through operating from a stronger bargaining, bulk purchaser position in the market for both products and support services. However, recent research (12) indicates that economies of scale may have changed for IS.

Focus On Core Business

Outsourcing can allow a client organisation to focus on its core business.

If Information Technology, computing and/or communications, are not core line of business, or are not in an area in which the organisation has a comparative advantage, then outsourcing can be of benefit.

Access To Skills

Client organisations can gain access to the skills they require as and when they are required, and can call on resources of the supplier for highly specialised skills and/or in unusual situations.

Access To Technology

Many organisations find keeping up with technical developments in computing and communications very difficult. Operational decisions in regard to the operation of computing and communications are often adversely effected by a lack of in-depth knowledge of the full range of technical options available. This can lead to using inappropriate technology and/or inappropriately using technology.

Flexibility

Many organisations find that they bear high fixed costs to cover an unbalanced workload. Maintaining the level of equipment and human resources required to cover workload peaks can leave an organisation with unfertilised resources for a significant proportion of the time. Outsourcing the workload peaks can bring considerable savings.

Accountability

Formalising service delivery brings greater accountability. A well written contract can clarify responsibilities and sharpen management focus on key deliverables (14) at project, operational and tactical levels. A further outcome of this formalisation can be a greater focus on service quality, and a consequent quality improvement.

Many of these advantages can accrue just from the process of examining the outsourcing option, as a consequence of self-examination and formalisation. That is to say that they can accrue without outsourcing per se.

Critical Issues with Outsourcing

While there can be advantages in outsourcing there are a number of things that can go wrong. It is prudent to stop and ask several questions (12) : what are organisation's intentions, what problems is it intended to solve questions (16), have vendors solutions to these problems? Organisational initiate outsourcing for reasons other than cost efficiency.

Transaction Costs

Outsourcing involves considerable costs in the administration of tendering and in the ongoing supervision and management of contracts.

Hidden / Additional Costs

One potential disadvantageous trade-off is the existence of hidden or additional costs. One of the hidden costs in an outsorcing contract can be the erosion of staff skills. Contracts generally provide for IT staff to move to the outsource company, with a guaranteed period of employment. This provides a pool of staff with knowledge of the client's business and local conditions. However, over time there may be cost pressures to use less trained and overseas staff, with a resulting lower quality of service.

Lack of Flexibility

Entering a long-term contract with a mainframe computer vendor may prove to be a disadvantage when changing business or technological circumstances bring a need to migrate to an alternative solution.

Loss of Control

It is essential that control over the information resource be carefully considered.

Human Resource Problems

If human resource management (HRM) issues are not handled well, any outsourcing venture will likely fail to realise advantages.

It is essential in all cases to develop `career options plans' for affected staff at an early stage. These must, at the least, involve an outline of the alternative career paths and employment options that the proposed outsourcing arrangements might involve.

Lock-In, Vulnerability and Dependence:

Lock-in to a long-term contract and to a single supplier can lead users back to a kind of vendor dependence that open systems promised to move them away from.

Contract failure and "backout" scenarios must also be explored and costed. Rebuilding in-house IT capabilities from scratch will be time consuming and expensive. The risk of having to do so must be quantified as far as possible, and backout and failure plans prepared.

Privacy and Confidentiality

Concerns over privacy and confidentiality are often cited as a major barrier to outsourcing IT functions. The issues of privacy and confidentiality must be covered within the contract, to protect the clients commercial interest and the interests of customers, suppliers, and employees of the client. But this need not be an insurmountable barrier.

Intellectual Property and Competition

Clear delineation of right over intellectual property within a contract is essential. This should be built on the foundation of a thorough intellectual property audit undertaken as a pre-cursor to outsourcing. The interests of third parties also need to be identified. Suppliers of IT hardware and software may place conditions on access to IP by staff of outsourcing company, where the company is a business competitor.

Opportunity Cost

A cost of the use of outsourcing is forgone benefits which come from alternative strategies. Before surrendering management control of a "strategic asset" and entering "partnerships", organisations should ask not "should we outsource IS?" "where and how can we take advantage of the rapidly developing market of IS services providers?" (13).

ACS Member involvement

ACS members may be involved in outsourcing as suppliers; consultants to any of the parties to the contract; and IT operatives, for either the outsourcing company or the agency being outsourced. In any of these activities ACS member actions will be subject to the Trade Practices Act, contract law and other streams of law. The ACS Code of Ethics (10) and Code of Professional Conduct and Practice (11) are highly pertinent to the outsourcing process, since a members ethical consideration for outcomes beneficial to the employer or client may, in some cases, lead to recommendations of personal detriment to the member.

ACS members may be involved in all of these aspects in the key concerns of:

ACS members could be involved in judging whether a case can be made that contracting out of IT will lead to better organisation outcomes compared with in house IT provision. In this context, ACS members may be asked to help determine how important are specific IT services to the achievement of organisation outcomes in terms of the degree to which the organisation's core processes depend on these IT services.

ACS members may be asked, on a specific case by case basis, what kind of impact the contracting out of IT will have on:

ACS members may be asked by either vendors or agencies to use their skills and special knowledge in:

Wider Issues

Outsourcing is consistent with the ethical provision of professional and technical services by ACS members to their employers or clients.

The application of Outsourcing by Government and major employers has significant implications for ACS members, however, working within all components of the outsourcing process.

Outsourcing should not be imagined to be a panacea solution to perceived IT problems. Used appropriately, it can deliver cost savings and other benefits, used inappropriately it can significantly diminish service levels, incur major reconstruction costs, and cause social damage. (Refs: 3, 4, 6)

Consistent and continuing evaluation of IT operations and services are important. Outsourcing can be part ensuring cost-effectiveness and quality service delivery and in maximising Australian technical and professional skills in IT.

Such assessment should be independently conducted according to established methodologies to ensure that the vested interests of neither vendors nor organisation personnel incorrectly impact the results.

"Whole of government" IT outsourcing is, however, a high risk approach (18). There are risks due to the large scale, long lead times, potential loss of services across government and differences in agency requirements. There may be difficulties in the Australian IT industry absorbing large outsourcing contracts. Other approaches might be used to achieve the desired cost benefits, with lowers risks and to permit the Australian IT industry to benefit. (7)(8)

Some case studies of outsourcing in public sector organisations (15) indicate that public sector information systems can be critical, complex and volatile, due to the nature of political decision making. This makes outsourcing less attractive. Recent indications are that the Australian Government understands that outsourcing should not chosen just to circumvent inflexibilities in the public sector accounting systems (17).

Outsourcing assessment processes are a valid tool for Government and private organisation in matching operations to strategic needs. However, particularly the case of government there is a need for processes to be open, accountable and participatory. Decisions made behind closed doors and communicated as a fait accompli are not in the public interest.

References

Comments to Tom Worthington MACS, President of the Australian Computer Society tom.worthington@tomw.net.au. An RFT version of this document indicating changes from the previous draft is available.

About the ACS

The Australian Computer Society was established in 1966 and is the recognised association for IT professionals in Australia; attracting a large and active membership from all levels of the IT industry, providing a wide range of services and opportunities for networking and career enhancement. It has become the public voice of the IT professional; the guardian of professional ethics and standards in IT; with a commitment to the wider community to ensure the beneficial use of IT.

See also