The Advantages and Disadvantages of Outsourcing - Literature review Example

Information Systems Outsourcing Table of Contents: Table of Figures: List of Figures Description & Word Hyperlink Figure 1 Relationship between firm resources & competitive advantages (Barney, J. 1991) Figure 2 Resource pooling mechanism of an alliance (source: Das and Teng. 2000) Figure 3 General Model for outsourcing management (Franceschini and Galetto. 2003) Figure 4 Conceptual framework of client – supplier relationship (Kern and Willcocks. 2000) Figure 5 The IS outsourcing framework (Fjermestad and Saitta 2005) Table of Tables: List of Tables Description & Word Hyperlink Table 1 Resource alignments in an alliance (Das and Teng. 2000) Table 2 Factors and Attributes of IS outsourcing (Yang and Huang. 2000) Table 3 Characteristics of types of relationships between outsourcer and Vendor (Franceschini and Galetto. 2003) Introduction: In the modern world of global competitiveness, it is critical for organizations to focus on their core competencies in order to maintain & improve the competitive advantages thus justifying of outsourcing the lesser critical tasks to ensure that they are carried out by people that are more equipped & experienced. The most complex decision making criteria prevails in outsourcing of Information Systems which forms the core of the business system in almost all the organizations in the modern world. Dibbern & Goles (2004) present four types of outsourcing arrangements – General (comprising of selective & value-added outsourcing), Transitional (technology migrations), Business Process Outsourcing (hotlines, helpdesk, call centres, document/record processing, etc.) and Business Benefit Contracting (vendors contribution to the client’s business – like closing deals). Outsourcing scope can be extended to single vendor, divided among multiple vendors or else carried out in hybrid mode (partly insourced). This paper critically examines the answer to the following question: What are the importance of Information Systems outsourcing, the best management practices in outsourcing decision, transition & management and the practical challenges in realizing benefits out of outsourcing? Importance of Information Systems Outsourcing To achieve sustained competitive advantages, an organization would need to build its value & rareness that is difficult for the competition to replicate or develop on their own. The information processing system that is deeply integrated with the management decision making process of an organization can potentially hold the value & rareness. The internal competencies are formed by virtue of heterogeneity, immobility, value, rareness, imperfect imitability, & substitutability of internal resources which may be people, processes or technologies as shown below (Barney, J.B., 1991): Figure 1: Relationship between firm resources & competitive advantages (Barney, J. 1991) These resources form a pool that are organised in the manner that is best suitable for sustained competitive advantages of a business. The value addition of the alliance depends a lot on the four essential components – rationale, formation, structural preferences & performance of the combined resource pool (Das and Teng. 2000). Figure 2: Resource pooling mechanism of an alliance (Das and Teng. 2000) The alliance performance thus depends upon collective strengths of the two firms whereby the resource alignments are carried out based on utilization & similarity requirements as presented in Table 1: Table 1: Resource alignments in an alliance (Das and Teng. 2000) Further to this, Dyer & Singh (1998) argue that effective outsourcing can be carried out by establishing four determinants of relationship – relation specific assets (site, physical assets, and human assets), knowledge sharing routines (inter-organizational learning), complimentary resources &capabilities, and effective governance (both way willingness in creating value). Mata & Barney in 1995 and the reaffirmation of their theory by Roy and Aubert (2002), Alvarez-Suescun (2007) and Bussarova in 2008 reveal that the primary aspect of outsourcing is that the business critical information & intellectual properties of the organizations should be kept out of the outsourcing framework and the transactional framework of Information Systems should be outsourced more to achieve similar or better business efficiency at lower costs. Aubert & Rivard (2003) presented the causal model & type of services that can be outsourced by a company – asset specificity (like managing IT hardware components), uncertainty, business & technical skills. To add to the theory the author presents the argument by DiRomualdo and Gurbaxani (2001) that the nature of relationship can be contractual or partnership depending upon the risks & uncertainties in deliverables by the third party organization. If the deliverables are clearly defined & measurable (having minimal risks & uncertainties) then the contractual model is suitable, however if there are uncertainties about the deliverables then the partnership model is more suitable. Another theory by Ang and Straub (1998) presents that the degree of outsourcing is dependent upon four measurable & tangible determinants – Production Cost Advantage, Transaction Cost, Financial Slack and Firm Size. Similar determinants have been worked out by Dibbern & Goles (2004) that are – Costs & Financial Situation, Financial Impacts, Strategy, Size, and Business Sector. Barthelemy (2001) and Auguste & Hao et al (2002) presented some hidden costs of IT outsourcing pertaining to vendor search & contracting, transitioning work to the vendor, managing the IT outsourcing on a day to day basis (monitoring delivery of services, information exchange co-ordination, trainings & knowledge transfer, etc.), and transitioning back after the tasks outsourced are over. In an earlier research by Vining and Aidan (1999), the determinants of outsourcing costs are presented as – product/activity complexity, contestability and asset specificity. In nutshell, it is not easy to manage the cost advantage in outsourcing business arrangements given the complexities of managing the engagement and the challenge to tangibly demonstrate the improved (or sustained) business efficiency of the processes. Best Management Practices in Information Systems Outsourcing Yang and Huang (2000) presented the Analytic Hierarchy Process (AHP) in constructing the decision process of outsourcing. This model requires building of a hierarchy of problems & sub-problems and then computes the comparisons, priorities and alternatives. They built the following factors and attributes of IS outsourcing: Table 2: Factors and Attributes of IS outsourcing (Yang and Huang. 2000) The primary decision criteria for outsourcing presented herewith are: Problems & ineffectiveness in IS department, need for focus on core competencies, learn & avail new technologies, reduced cost and higher reliability & performance of IS leading to higher business service levels. Lankford and Parsa (1999) insisted on analyzing economies of scale, inability to manage the function in-house, strategic realignment, need for focus on core business, short & long term financial advantages, and impact on company’s competitiveness. They guided to identify the services to be outsourced, number of suppliers to be used, ability to take back the operations in-house (if required), supplier reliability & quality, co-ordination with supplier, evaluation of performance and provision of latest & advanced innovations & technologies. Franceschini and Galetto (2003) formulated these theories in the form of a model of outsourcing decision making presented below: Figure 3: General Model for outsourcing management (Franceschini and Galetto. 2003) Their model presents a step by step procedure to execute outsourcing of processes: (a) Step 1: Identify the processes that can be outsourced after in-depth evaluation of the core competencies of the organization (b) Step 2: Evaluate all types of vendor relationships with respect to the business requirements of the processes – as presented in Table 3. (c) Step 3: Stratification of activities that shall occur in the outsourcing arrangement (d) Step 4: Selection of the outsourcing partner (e) Step 5: Agreements on service level agreements and their measurement/monitoring procedure (f) Step 6: Agreement on the methodology of Management of the outsourcing arrangement. (g) Step 7: Agreement on transactional costs and the bearer of such costs – includes bargaining costs, monitoring costs, contractual opportunism costs, market costs, management costs, Table 3: Characteristics of types of relationships between outsourcer and Vendor (Franceschini and Galetto. 2003) Kern and Willcocks (2000) presented a conceptual framework of client – supplier relationship from the perspective of interactions & behavioural aspects as shown in figure 4. Figure 4: Conceptual framework of client – supplier relationship (Kern and Willcocks. 2000) The interactions between the client and vendor shown herewith are the keys to establishment & management of the behavioural work environment between both parties that benefits both the sides mutually with respect to their individual business objectives & expectations from the engagement in fulfilling those objectives. From the perspective of IS outsourcing, Fjermestad and Saitta (2005) present the following strategic framework that focuses on the cycle of decision making from alignment to business strategy to governance of the outsourcing relationship. The cycle is similar to the analytics that we have presented till now except that infrastructure is included as one of the major decision making criteria. Figure 5: The IS outsourcing framework (Fjermestad and Saitta 2005) The desired technical environment must be at least similar to the existing internal environment of the outsourcing company that includes hardware, software and networking. Technology standards, scalability and security are key elements of an effective infrastructure at the vendor’s end. Key Challenges to the Best Practices faced by real world organizations The author hereby presents the perspective of HSBC Bank in outsourcing. The financial sector largely has been leading among those sectors that heavily relied on outsourcing business processes & technology development. HSBC owns captive software development centres in India, China & Brazil and also owns business processing centres in five cities of India. HSBC concluded to outsourcing due to the following reasons: (a) Technology improvement: The requirement of rapid technology improvements was getting difficult in managing in-house by the Bank. HSBC didn’t go for outsourcing only to reduce cost of technology management & enhancements but also to create much larger pool of technology professionals that can be used as and when the demands increased. (b) Rapid upgradation of their age old Hexagon System: HSBC was facing the risk of brand dilution as their banking system called Hexagon was 18 years old. They wanted a dedicated team to work on its upgradation on war footing such that they can roll out the upgraded version in all the 32 countries where HSBC operates. They could achieve this task in just 18 months at their offshore development center at Pune (a satellite city of Mumbai, India) comprising of 80 engineers. (c) They believed in the hybrid model whereby they divided the work between their own captive unit and a third party vendor called Kanbay whereby both HSBC captive management and Kanbay management devised a joint plan and conducted joint management review meetings. (d) The primary focus of HSBC’s outsourcing strategy has been quality of deliverables and retention of key staff. HSBC maintained a retention rate that is far higher compared to the market average in India. Further to this HSBC believed in long term outsourcing relationships allowing the short term goals to be achieved in-house. [Kriplani, 2006] For support & maintenance of the upgraded system, HSBC selected Dukestar Technologies that provided them onsite resources as well as helpdesk resources to operate from Pune. Support & Maintenance operations require much more in-depth involvement compared to development operations. This is because development operations are carried out on isolated hardware & software systems that do not possess any integration with the production environment for customers. The final developed completed codes are rigorously tested in a testing environment and then made-live into the production environment. If the new codes do not work, the production system is rolled back to the old codes. These operations take multiple steps requiring rigorous involvement of both the sides and hence the probability of failure is lesser. However in application maintenance & support operations, the vendor is provided direct access to the production environment thus leading to higher risks of the outsourcer. In such a case, a malfunction by the outsourced employees can lead to disastrous results for the Bank. Hence, to select the outsourcing vendor, HSBC conducted multiple rounds of evaluations of multiple companies. The primary aspects of their outsourcing of application maintenance & support were: (a) Understanding the technology infrastructure and skills of the outsourcing vendor: The infrastructure on which the vendor will provide support & maintenance of bank operations needed to be robust & reliable such that all support operations can be carried out seamlessly. Aspects like speed of computers, quality of voice in long distance communications, 24 X 7 operations capability, power backup, etc. are very critical for the outsourcing operations of critical business processes. (b) Understanding their business continuity capabilities: Given that application maintenance involves direct support to business processing staff, the SLAs need to be met religiously. The bank cannot afford to miss support calls due to outages or else complete halting of support operations due to disasters. Hence, HSBC verified the Business Continuity capabilities of the vendor that essentially includes technology recovery plans against failures, or shifting of operations at an alternate site if the primary site fails. The primary interest of such a plan is its probability of success that is assessed through rigorous testing. (c) Understanding their Information security readiness: Given that the vendor will have access to business & customer’s critical data, the Bank was interested to understand how the information security controls are deployed in the vendor’s organization. In the banking world, certain standards like ISO 27001 are mandatory to be implemented to ensure end to end security readiness of the organization against hacking, attacks or malicious intent of internal employees. Colwill and Gray (2007) argue that the risk assessment picture becomes more complex when the Information Systems are outsourced and hence the operational & business risk framework changes significantly. [Duke Star Technologies at www.dukestar.com/pdf; Colwill, C and Gray, A. 2007; Solnestam and Velasquez. 2005.] Bob Carlson, former head of IT & Telecommunications at HSBC presented a detailed strategic outlay from HSBC’s perspective to Outsourcing times. He presented the HSBC’s outsourcing checklists that advised outsourcers to watch out for the following: (a) The key driver for outsourcing strategy should be the business strategy (b) The outsourcer should not outsource the part of IS that is encountering problems because outsourcing is not viewed as the means to sort out technical problems. Bob advises that all technical problems should be sorted out before outsourcing. (c) The Sarbanes Oxley legislation in US prohibits outsourcing risk management. However, this control should be followed by all outsourcers worldwide – Risk management or any other business process that requires extreme levels of confidentiality of information should never be outsourced. (d) Outsourcing should not be allowed to deskill internal competencies to the extreme. The vital competencies should always be retained in-house. (e) Bob feels that risk of outsourcing increases with distance of the outsourcer from the vendor. This is one of the reasons that HSBC preferred to have own captive units in India that are completely owned and managed by the corporate. (f) Outsourcing costs must be factored in marketing costs & profit margins of the outsourcer. (g) Any cost savings in outsourcing will eventually be passed on to customer due to all in competition doing the same – and hence outsourcing should not be viewed as means to increase profit margins. (h) The original business strategies & requirements when deciding for outsourcing is bound to change and hence the agreement should be kept flexible & renegotiable to incorporate new business requirements. (i) Detailing out relationship, partnership and problem resolution terms are more important than work scoping, service levels agreements & price agreements. (j) The contracts & relationships should be established in such a way that they do not depend upon the people who initiated them. People at both sides might move on which should not hamper the relationship. (k) The contract negotiation should be carried out by own marketing people and not only by the IT leadership – this shall result in better negotiation of terms & deals. (l) Every outsourcing contract should have clearly defined exit clause (m) Outsourcing deals are joint ventures and hence both sides should have capability to invest as and when required. The outsourcer should not blindly take all the costs of either side. [Offshoring Times. 2006] Mapping with the theoretical framework of Fjermestad & Saitta (2005), Franceschini & Galetto (2003) and Kern and Willcocks (2000) we hereby observe that HSBC focussed on price & strategy, technology infrastructure, trust, supplier capabilities, type of contract, shared vision, socio-cultural bonding, long term strategic partnership, service enforcement & governance, cost sharing, and risk sharing. The HSBC mode outsourcing has resulted in enormous success as we can observe that they followed the best practices that are formed out of multiple empirical generalizations as is evident from the theoretical frameworks established by these researchers. The author’s perspective of addressing these challenges in the role of Hybrid Manager The author hereby proposes that the hybrid model of outsourcing is the most suitable as is evident from the learning from HSBC case study. The hybrid model that the most preferred is the following: (a) Developing a framework of target advantages, cost model (including hidden transactional costs) and the management portfolio that shall be practiced in outsourcing: The author proposes to use proven strategic framework like Michael Porter’s Diamond model, Balanced Score card system and SWOT analysis to develop the framework of advantages of outsourcing. The framework shall be very carefully analyzed from the perspective of value addition to customers, financial advantages, benefit to internal learning & growth, stake holder’s enhancement of equity, reputational aspects of the organization, impact on core competencies, impact on employees, etc. (b) Developing own captive offshoring in a low cost destination like India: As directed by Bob Carlson, the former Head of IT & Telecommunications of HSBC Bank, the distance of outsourcer from the vendor increases the risk of outsourcing. This is a significant consideration in the overall planning framework. Hence, the author’s preference shall be to purchase a 100% owned subsidiary in the remote outsourcing location like India, Philippines, etc. and include such cost as strategically important for the framework to become successful in the long term. The author’s preference shall be to encourage internal IT governance staff to invest substantial time on-site in the captive, whereby some of them may be positioned permanently. The outsourcing framework shall expand from this location by evaluating & selecting the best vendors and managing the work transition through the captive system. The infrastructure of the captive system shall be deployed as per the standards & baselines of the parent company. (c) Hiring the best talents in the nation by offering lucrative pay packages & challenging job opportunities: The author proposes to hire the best talent from the local market in the captive unit to ensure that they form an extension of the existing employee base that shall work towards development & management of the outsourcing vendor base in that country. This would reduce cost of management & interactions of outsourcing significantly. (d) Short-listing some of the competent and right sized third party vendors with competencies similar to those of the captive unit: The author proposes to shortlist vendors locally at the captive site such that cost of short-listing reduces significantly. (e) Closing on the best partner and asking for a large part of the team to be stationed in self owned captive building in India such that they use the same infrastructure: The best partner (or partners) among the short-listed companies shall be awarded the contract. (f) Setting up policies & procedures that are common to both the resource pools: The policies & procedures for governance of the outsourcing framework shall be established in such a way that employees of the vendor & the captive units shall be governed by the same policies & procedures. This may include information security policies & procedures, non-disclosure agreements, operating framework, reporting lines, hours of operations, code of conduct, etc. (g) Transferring knowledge to the combined offshore workforce by virtue of on-the-job-trainings & internal certifications: The knowledge shall be first transferred to the captive unit and then shall be transitioned from there to the vendors through very carefully defined channels. Most of the documentation shall be maintained on-site at the captive unit and vendors will be allowed to access them remotely through the local wide area network infrastructure. The on-the-job trainings and class-room sessions shall be conducted in the premises of the captive for employees of both the sides. (h) Carefully dividing the work between the two resource pools and ensuring a common management controlling both the sides: The work shall be divided in such a way that less critical work shall be transitioned to vendors and relatively more critical work shall be transitioned to the captive unit. (i) Establishing a procedure for consolidating their deliverables into one: The author shall establish procedures to consolidate the deliverables of both sides at the hardware & software platforms at the captive site which shall then be transitioned to the infrastructure of the outsourcing company over international links. Software support & maintenance services shall be managed through the captive unit only whereby resources from the vendors shall be provided physical space at the captive unit. (j) Establishing consolidated quality assurance procedures: The author proposes to establish consolidated quality assurance procedures at the captive unit. For this purpose, the organization may have to invest in test & certification infrastructure at the captive premises. (k) Establishing consolidated make-live strategies to the end users. This mode of operandi will allow best usage of both the modes and still de-risking the organization from security issues of using third party infrastructure and losing critical knowledge & competencies to the third party vendors. In fact the author shall emphasize management of the knowledge & competencies at the captive because the employees of the captive shall be integrated with the larger human resources framework of the parent company in due course thus becoming own intellectuals of the parent organization like any other employees hired across the world. The author has proposed the steps of outsourcing decision framework in line with the steps proposed by Franceschini and Galetto (2003) keeping in view the five critical factors recommended by Yang and Huang (2000) as Strategy, Management, Technology, Economics and Quality and the decision cycle presented by Fjermestad and Saitta (2005) comprising of – Management Support, Culture, Contractual Model, Infrastructure, Strategic Partnership, Governance and Alignment to Business Strategy. Conclusion: In this paper, the author presented the outcome of literature review in the form of advantages & disadvantages of outsourcing and the decision making models for concluding on outsourcing, deciding on the technologies/processes to be outsourced, deciding on the right engagement model, selecting the right vendor, agreeing on desired service levels & transaction costs, agreeing on management & monitoring methodology, transitioning process of work and finally managing the engagement. The methodology followed in the paper is evaluation & consolidation of outcomes of literature reviews. Finally, the author has presented a brief review about HSBC’s strategy of outsourcing and the preferred model of hybrid outsourcing. Reference List: Alvarez-Suescun, E. 2007. “Testing resource-based propositions about IS sourcing decisions”, Industrial Management & Data Systems, 107( 6), 762-779 Ang, S. & Straub, D. 1998. “Production and transaction economies and IS outsourcing: A study of the US banking industry”. MIS Quarterly, 22(4), 535-552. Aubert, B.A., Rivard, S. & Patry, M. 2004. “A transaction cost model of IT outsourcing”. Information & Management, 41, 921-932 Auguste, B., Hao, Y., Singer, M. & Wiegand, M. 2002. “The other side of outsourcing”, McKinsey Quarterly, 1, 53-63. Barney, J.B., 1991. “Firm resources and sustained competitive advantage”. Journal of Management, 17(1), 99-120. 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