Objectives of outsourcing

Outsourcing had emerged in manufacturing industry well before it became a serious strategy in IT management. For example, the vertically integrated structure of the automobile industry in the first half of the 20th century was forced by market pressure to adapt to a more dis-integrated form. In this a concentrated number of auto

assemblers emerged that was supported by a much larger base of (mostly independent) parts manufacturers (Lamming, 1993). A model of collaboration emerged in which the development of innovative components was effectively outsourced up the supply chain by the assemblers. In this industry, outsourcing assumed an objective of dividing areas of knowledge and the connected responsibility for innovation between organisations. Each organisation took responsibility for the knowledge it was best placed to develop and to deliver to its collaborators in the wider industry value chain.

Collaboration in innovation is a common objective to both manufacturing and IT outsourcing, but differences began to emerge in the late 1980s as a variety of distinct

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IT outsourcing models emerged (Loh and Venkatraman, 1992, Lacity and Hirschheim, 1993a). Outsourcing could satisfy clients’ objectives for obtaining high quality yet generic IT services, this contrasted with the more product specific and knowledge intensive manufacturing processes seen in the auto industry . Quinn et al (1990a) described this saying; ‘…value added is increasingly likely to come from technological improvements, styling features, product image and other attributes that only services can create’ (p.58). The IT outsourcing industry emerged as a provider of such

services, and was fuelled by the growing use and importance of IT across organisations.

The reasoning behind such large scale IT outsourcing projects was quickly questioned by some authors and raised issues that remain to today. Two specific reasons (or ‘myths’) for its early and rapid growth in popularity were identified and debunked by Lacity and Hirschheim (1993a, 1995). First, they claimed that IT outsourcing at that time was a ‘bandwagon’ strategy for management teams. Its early reported success in large firms like Kodak (Applegate and Montealegre, 1995) where IT was seen as a commodity had ‘prompted many executives to outsource without due consideration of the potential consequences’ (Lacity and Hirschheim, 1993a, p.74). Another

conclusion from rapid early adoption could have been that the bandwagon was

created as executives came to see IT as a commodity and believe that no competitive edge could be achieved through its retention in house. This view was broadly in line with that of the contemporary core competence theorists (Hamel and Prahalad, 1994, Quinn and Hilmer, 1994). More recently sourcing strategies have evolved to embrace the benefits of dividing an organisation’s value chain into smaller pieces, the argument shifting to one of how this division can be most optimally achieved (Contractor et al., 2010).

The second ‘myth’ of IT outsourcing was that it could achieve savings of 10% to 50% of IT costs. Lacity and Hirschheim pointed out that firms’ own IT departments could achieve similar results (which might have been true but does not make the possibility of large cost savings from outsourcing a myth) and thus tacitly acknowledged that savings of this scale, however achieved, were available at that time. That a transition to outsourcing generated new costs came possibly as a surprise to managers and was considered in academic literature (Barthelemey, 2001). These included the costs incurred in searching for the vendor, in transition from old to new situations, in

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monitoring of the contract and in its eventual unwinding. However, the potential of IT outsourcing to offer compelling cost savings was maintained and continued into the 21st century with the growth of offshoring. Here, clients and vendors used a variety of sourcing models to access low cost IT resources, especially in South Asia, making significant savings compared to labour rates in developed markets (Pfannenstein and Tsai, 2004, Rottman, 2008a).

Outsourcing could (and does) at least offer clients the possibility of guaranteed success against a cost reduction objective when cost savings are enshrined in the vendor’s contract. This provides the client with a legal recourse that is impossible to achieve when an internally managed IT team is used (Masten, 1988). It was this justification that probably contributed to the growth in the 1980’s and 90’s of wide ranging, long term ‘total’ IT outsourcing deals like Kodak and the UK Inland Revenue case described by Willcocks and Currie (1997).

A further set of risks in defining objectives for IT outsourcing were proposed by Earl (1996). This included the recognition that the uncertain nature of IT would cause problems in defining the contract. Earl stated that ‘IT operations and development have always been uncertain. Users are not sure of their needs, new technology is risky, business requirements change, and implementation is full of surprises’ (p.29). Earl proposed that flexibility should be built into outsourcing contracts, even if this came at a cost. Earl also pointed to a risk that organisational learning ability would be compromised by a loss of insight into the capabilities and potential of information systems as these are outsourced.

A somewhat contradictory view is that that well designed contracts can encourage the vendor to develop core competences that are mutually complementary to those of its client (Levina and Ross, 2003). This complementarity allows the vendor to deliver improved performance, client satisfaction and growth in its own scale. Client

organisations are unable to develop the same set of competences because factors in their hierarchy can intervene. For example an organisation might find it difficult to centralise IT decision rights in its IT team whereas an outsourcing vendor can achieve this through the service contract. Control over decision rights allow the vendor to develop a competences in productivity and cost management which are unavailable to the client firm acting independently.

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The question of competence development as an objective of outsourcing was addressed more broadly by Susarla et al (2010). Incentives, agreed in the contract, encourage vendors to invest in the client relationship (Susarla et al., 2010). This research points to the risk of the vendor being disadvantaged in future negotiations if these incentives are not in place saying, ‘In the absence of appropriate incentives, vendors will underinvest in non-contractible specific investments, which lowers the value from outsourcing’ (p.37). This shows the difficulty of obtaining innovation through outsourcing; unless the requirements for the vendor to be innovative can be contractually stated and protected at the outset, the incentives for the vendor to invest speculatively in building systems and knowledge needed to support innovation are low.

A variety of forms of outsourcing exist and decisions around these should be systematically linked to the objectives an organisation sets for the complementary resources is possesses (Insinga and Werle, 2000). This research proposed that an organisation’s objectives concerning its strength in a particular function should be related to that function’s potential to generate competitive advantage. Based on this, an optimal way of acquiring the services needed to perform the function from the market was proposed. The umbrella term 'outsourcing' becomes a set of choices that include buying services, collaborating, partnering with expert providers or disposing of non-strategic functions to release capital and buying back their required outputs. Adopting this approach could allow an organisation to comply with industry level trends towards specific functions becoming non-strategic in nature. These functions could then be sold or outsourced and scale benefits secured as vendors aggregate the function across multiple firms in the industry. Insinga and Werle thus take a refined approach to outsourcing. They challenge the 'total' approach seen in the 1990s and before, acknowledging that functions with potential to generate competitive advantage might be retained in the organisation. To benefit from this however, an organisation must not only recognise a function as non-strategic but also be confident that it will stay that way, a challenge in IT which is characterised by rapid and unpredictable capability development.

A still more detailed view of the objectives or drivers for outsourcing was developed by Kroes and Ghosh (2010). They identified 19 separate drivers and mapped these to generic competitive priorities of cost, time, innovativeness, quality and flexibility that

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would be found in a manufacturing environment. The empirical research they

conducted demonstrated that outsourcing can best succeed when the organisation’s strategic priorities and its drivers for outsourcing are closely aligned. It also found that the reduction of total costs was the single most significant driver for outsourcing. While this research was conducted among manufacturing organisations and not

specifically IT focussed, the generic priorities are likely to be relevant to IT outsourcing situations.

In the early 2000s, the outsourcing of entire business processes (BPO) was

developed. Here, a broader scope of client objectives allow the outsourcing vendor’s responsibilities to increase beyond the management of technology to include the processes the technology enables. Willcocks et al (2004) described how BPO deals offered clients significant cost and efficiency gains as well as access to vendors’ skills and scale potential. However they also pointed to the risk that clients could lose significant internal business process know-how an effect that would only become apparent over time. They wrote ‘…knowledge implications may well be disguised for a time by real cost and service improvements [from BPO], simply because so many back-office business processes inherited by suppliers are so inefficient.’ (p.11). This was somewhat contradicted by survey based research in 2011 and 2012 which

claimed that many users of BPO were benefitting from innovation in service provision. These innovations were often originated and funded by the outsourcing vendor, or by the vendor in conjunction with the client (Lacity and Willcocks, 2013).

In recent years two further objectives for outsourcing have emerged: access to

specialist knowledge and, through the development of offshore outsourcing; the ability to understand and exploit foreign markets (Contractor et al., 2010). The development of more outsourcing supply and the technological tools to manage time critical

relationships across the globe offers management an increased choice of functions to outsource. This allows organisations to challenge historic definitions of what functions are actually ‘core’ and draw a new distinction between truly core and ‘essential’

services, using outsourcing as a means of sourcing the latter. Hence, between the 1990s and 2010, outsourcing has been seen to develop from a ‘blunt instrument’ sourcing tool to a more refined technique for finding and using a range of suppliers on a potentially global basis.

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More recent literature identified that different IT outsourcing choices can be made within an organisation’s span of IT activities. This further challenges the ‘one shot’ approach as was demonstrated in the Kodak case mentioned above. Based on

extensive case research, Willcocks et al (2011) proposed a process for assessing how IT activities might be suitable for outsourcing. A range of variables was considered in this: the contribution of the activity to business operations and to competitive

positioning, the level of capability available in the market compared to internally and the relative cost, adjusted for transaction costs. Following such a set of rules would lead to a rational decision on what to outsource and an indication of to which vendors outsourcing contracts could be given. Adopting a more intricate and detailed process of assessment such as this could address some of the problems of inadequate

foresight discussed as a criticism to Insinga and Werle (2000) above.

In summary, the outsourcing literature describes a path towards more and more refinement in outsourcing decisions. This was well summarised by Willcocks (2011) as a learning curve showing how IT outsourcing has developed from its early origins: in this, the initial ‘hype’ of IT outsourcing as a simple shift of non-core activities out of an organisation to a single expert vendor has developed into a much more

sophisticated model. Today’s model of IT outsourcing is one where selected IT and business process activities may be moved to a number of vendors using different contractual and governance forms. This can lead to the creation of multiple

outsourcing enclaves in a single client organisation. Further, the globalisation of IT services delivery means the vendor activities that contribute to these enclaves may be located in the most cost efficient places around the world. Some IT activities might be retained in-house when internal resources they use are assessed as more effective, alternatively some entire business processes may be moved to a vendor, building scale efficiency by aggregation of demand across client organisations.

As outsourcing practice has developed, so has its incorporation into the wider management systems of the client organisation. The next section will describe outsourcing from a perspective of structure and governance.

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