The Reasons Why Organizations Outsource IT - Essay Example

Factors and Issues in IT Outsourcing Introduction IT outsourcing has become a common phenomena in the current business environment. Aided by a desire for cost reductions and efficiency along with the availability of external data management services, IT outsourcing has become a more convenient alternative for many companies seeking to use their resources more efficiently. At the same time, placing competitive information in the hands of an external party necessitates continuous relationship management. This paper discusses some of the factors that motivate organizations to outsource their IT functions. This is followed by a critical analysis of the main issues that organizations need to address when managing relationships with their IT outsourcing partners. 2. Reasons for Outsourcing IT 2.1 Critical Value and Perception of the IT Function Organizations base their IT outsourcing decisions on a number of factors; however, the most common reason for outsourcing IT functions to a professional IT vendor is that it enables organizations to focus on their core area of expertise. Heikkila and Cordon (2002) have identified this and other reasons behind organizations’ decision to outsource IT. For instance, outsourcing the IT function frees up the limited capital of small and medium-sized organizations to invest in core competence areas. Firms that do not have skilled IT professionals can benefit from the expertise offered by outsourcing service providers. Despite rigorous analysis of all these factors and effective decision making by the organization, the outcome of the outsourcing arrangement depends largely on how the decision is implemented. Therefore, it is important that the implications of each step in the implementation process are identified and contingencies are provided for in advance to realize the intended benefits of IT outsourcing. Organizations may also be motivated to outsource their IT function because of the value it may add to the performance of some of their core functions. Such organizations may have a critical value for IT but may not possess the skills and resources to extract that kind of value from their IT assets. Davis and Golicic (2010) explain how information systems play a crucial role in the supply chain relationship of some organizations. By making information about market needs and stock levels to partners throughout the supply chain, information systems enable organizations to manage their distribution and transport systems more efficiently. Demand levels can be met more accurately and develop a market orientation. Sundaram, Schwarz and Jones (2007) discuss the motivation underlying organizations’ decision to outsource IT functions from a different perspective. In several organizations, front-line employees are generating huge volumes of customer and market-oriented information through the increased use of IT devices. Over time, as frontline employees such as sales staff become adept in the use of such devices, the volume of information increases rapidly. Moreover, organizations have the opportunity to mine this information for competitive insights into market needs, shifting consumer preferences and emerging trends. Hence, in situations where the organization may not possess the resources to process huge volumes of data efficiently, the decision to outsource the IT function to a reliable vendor may be made. Pultz (2011) discusses several reasons that organizations base their IT outsourcing decisions on. Although cost saving is often cited as a major reason, other factors are equally important. Most importantly, organizations seek to focus their efforts on their core competence and prefer to outsource noncritical functions to third party service providers. IT is an important support function in several types of organizations such as manufacturing, banking and so on. By outsourcing this function to professional outsourcing partners, organizations can not only save costs but also find new ways of analyzing their data for strategic value. The decision to outsource the IT function may enable organizations to improve their service quality levels (Julien et al., 1998). However, it is not always necessary that organization will be able to offer better service unless the IT function is non-core and they can rely on their outsourcing partner to respond quickly to immediate needs for IT service. Organizations should carefully assess the role played by the IT function in shaping their service quality. It is equally important to rigorously assess the competencies, resources and skills of their IT vendors. At the same time, it the intended benefits of IT outsourcing cannot be realized unless the outsourcing partners are flexible and can fulfill their contractual obligations at all times. With a trusted and reliable IT outsourcing partner, organizations can be assured that their service levels will improve and they will realize significant cost savings over the medium and long term. IT Outsourcing decisions are also frequently underlined by the way in which the IT function is viewed by the client organization. This view is related to the distinction between IT as a critical and non-critical function and concerns the role that IT enjoys in the particular organization. As explained by Weeks and Feeny (2008), organizations that view IT mainly as a support service provided by the IT department are likely to view the IT function as a commodity that does not offer unique advantage to the organization. Such organizations are likely to outsource the IT function under cost considerations. Alternatively, organizations may adopt a quality focus or an innovation focus depending on how instrumental the IT function is in enabling the organization to create business value or perform key business functions efficiently (Weeks and Feeny, 2008). Consequently, such organizations may decide to retain the IT function in-house unless they can forge extremely reliable strategic-level relationships with IT outsourcing partners. A similar distinction is made by Holweg and Pil (2012) as they differentiate between traditional outsourcing of IT functions and the more strategic enterprise partnership between the organization and the vendor. Organizations are likely to decide in favour of enterprise partnership where outsourcing can help them improve the efficiency of ther business processes and earn greater profit. Such organizations are more likely than conventional IT outsourcing organizations to enter into long-term service agreements and leverage the business assets of their outsourcing partners to derive scale economies (Holweg and Pil, 2012). In such cases, the organization decides to benefit not only from the technological expertise of the IT vendor but also from the ability of the vendor to help the organization improve operational efficiency and service quality. Outsourcing decisions based on cost considerations are mainly motivated by short-term interests whereas their firms may enter into IT outsourcing arrangements as part of a long-term continuous improvement policy. Gonzalez, Gasco, and Llopis (2010) have highlighted the value that organizations seek by outsourcing their IT function to third party service providers. It has to be noted that in their research, cost saving does not emerge as the top motive for organizations to make the outsourcing decision. In fact, organizations are more concerned with getting the best technological resources at their disposal which can help them to make the most productive use of their information assets. However, outsourcing clients are also concerned about the competence levels of their outsourcing vendors as well as their ability to be flexible and innovative. This tendency is reflected in the findings of other scholars which will be discussed ahead in this section. These priorities indicate the shift towards the knowledge economy where competitive advantage is determined by the quality of information processing of an organization. The changing economic and competitive landscape of business is placing greater pressures on organizations to become competitive. The current diktat of the business environment is that mediocre performance based on short-term perspectives is not going to help the organization survive well into the future. Power (2013) shows how organizations are adopting a strategic orientation particularly in reference to their IT outsourcing decisions. Among the IT functions that are the most attractive choices for outsourcing are knowledge process outsourcing to vendors who possess stronger analytical and diagnostic skills to extract high-value insights from the data provided by their clients. In addition to cost savings, Power (2013) argues that organizations decide to outsource their IT functions in order to expand their IT capacities by harnessing the resources of their vendors. Firms also decide to outsource their IT function when it helps them to innovate their information processing systems. 2.2 Skill Gaps The outsourcing decision is a highly complex one particularly where research shows that the ultimate performance of the organization is determined by factors in addition to the decision whether or not to outsource IT (Leiblein, Reuer and Dalsace, 2002). According to this view, organizations may be unable to derive the benefits of an outsourcing decision if they do not possess the skills and resources to support the vendor through relationship management and apprising the vendor about the changing needs of the organization. Hence, organizations compare the IT resources possessed by the vendor with their own resources as well as their competence at using those resources efficiently. The innovation strategy of the organization also plays a major role in determining whether the organization outsources its IT function or chooses to retain it (Leiblein, Reuer and Dalsace, 2002). In a study conducted by Saunders, Gebelt and Hu (1997) most of the organizations surveyed based their IT outsourcing decisions on the fact that they did not possess technological resources and competencies in-house. Thus, one of the main reasons for outsourcing IT is obtaining quality services that allow the organization to integrate technology into its main functions. Furthermore, organizations are motivated by strategic considerations such as the ability to gain access to scalable IT infrastructures and resources in less time compared to building proprietary resources from scratch. In this way, outsourcing helps organizations to bridge the gap between their performance and that of their main competitors. Organizations may also decide to shift their IT function in order to utilize their IT resources more efficiently and by reallocating human and physical resources to other critical business functions (Saunders, Gebelt and Hu, 1997). 2.3 Cost Factors The factors that motivate organizations to outsource their IT functions may be understood by the transaction cost theory (Gottschalk and Solli-Saether, 2006). The authors explain that under the assumptions of the transaction cost theory, organizations are motivated by a desire to reduce their overall transaction costs to become more efficient and competitive in their industry. To achieve these cost reductions, organizations may undertake investments in durable, specific assets that can reduce the difficulty of measuring task performance and reduce environmental uncertainties. Hence, it may be argued that organizations are motivated by a desire to achieve a reasonable level of stability and predictability in a highly complex and turbulent environment. As the IT industry is the most disruptive and turbulent industry, organizations where IT is performed as a support function may find themselves incapable of keeping up with the changing standards. In such cases, they may seek to outsource the IT function to a professional IT vendor. This may be explained further by the findings of Collins, Ketter and Gini (2006) who discuss the value added to the outsourcing relationship by a formal and efficient bid evaluating system. The authors also discuss the preference of organizations for entering into multistep task outsourcing arrangements with third party vendors in order to leverage the assets and competencies in the relationship. This kind of outsourcing allows organizations with limited resources to benefit from a pool of IT resources and competencies where various tasks are performed by the party who possesses the skills and capacity to perform them most efficiently. Cost savings is also an important factor which emerges in the research conducted by Saunders, Gebelt and Hu (1997). 3. Crucial Issues in Managing IT Outsourcing Relationships 3.1 Trust and Communication Issues Research shows that managing IT outsourcing relationships effectively can reap attractive benefits to the organization. Through effective management of the outsourcing relationship, organizations can make optimum use of IT process knowledge and resources, bring about innovation and attain cost savings. Poston, Kettinger and Simon (2009) suggest that organizations should work towards striking a balance between building collaborative, trusting relationships and encouraging competition among suppliers. Some of the issues that arise in managing a portfolio of vendors including ensuring that high collaborative efforts are put in, building relationships with new entrants to the industry who are likely to possess more sophisticated and current knowledge, terminating relationships amicably with old vendors without incurring loss of IT knowledge and encouraging healthy competition between the vendors (Poston, Kettinger and Simon, 2009). Developing and maintaining trust is one of the major challenges that emerges in similar research conducted by other scholars. For many organizations, this may be the single incident of outsourcing and considering the fact that proprietary data is transferred to an outsider, it can result in a certain level of anxiety. Thus, it is important to address the issue of trust in IT outsourcing relationships. This aspect of outsourcing relationship management is addressed by Soderstom and Lennerholt (2006). The authors explain the reasons why trust becomes a critical issue in outsourcing relationships. Some of these reasons include the lack of information about the skill of the vendor in handling client data as well as the robustness of the data security systems of the outsourcing partner. Cultural differences as well as differences in communication styles can also give rise to trust issues in the outsourcing relationship. Nguyen, Babar and Verner (2006) have also written on the issue of trust in IT outsourcing relationships. According to them, trust issues often arise in outsourcing relationships because they are a crucial determinant of performance quality and performance standards. They differentiate between the factors that are involved in creating trust and those behaviours required for maintaining trust over the duration of the relationship. The former include understanding cultural differences, building credibility and undertaking personal visits to the offices of each party; whereas the latter include behaviours such as adopting open communication styles, adhering to the terms of the contract and delivering the contractual obligations on time. It can thus be argued that managers need to constantly work on building trust with the vendor in a way that vendor’s perceive their role in the relationship as a partner of the client (Nuyen, Babar and Verner, 2006). In managing outsourcing relationships, organizations also have to build social capital to ensure that the confidence and trust between the partners is maintained over time. This needs to be built up right from the stage of vendor selection. There are various ways in which organizations can go beyond the proposal submitted by the prospective vendor to appraise the skills and competencies of the IT outsourcing partner. Rottman and Lacity (2004) suggest that vendors can be assigned pilot projects to work on before the outsourcing function is assigned to them. This strategy allows organizations to assess the relationship before a long-term commitment is made. Organization representatives can make visits to the vendors during this period and solicit referrals from previous and current clients (Rottman and Lacity, 2004). The issue of communication quality between the outsourcing partners has been discussed by a number of researchers. In such an arrangement, the two parties have to operate as a virtual team by using communication technology tools. Kiesler et al. (2008) explain that achieving the promised results of an IT outsourcing arrangement is dependent upon the level of trust and communication openness between the client and vendor. One particular cultural difference that emerges in offshore IT outsourcing arrangements is the status difference in the respective cultures of the two parties. Hence, clients in western countries may have to employ greater tact and show deference to their counterpart in the vendor organization. However, it is unreasonable to argue for greater responsibility by the client organization without acknowledging the role of the vendor organization in maintaining the outsourcing relationship. The client representative may need to remind the vendor representative frequently to provide the contracted service levels. In addition, as stated by Feeny and Willcock (1998), the client representative may need to practice contract monitoring to ensure that performance is being provided as expected. Although both the parties are responsible for performing their share of the duties, it is ultimately in the interest of the service recipient organization to ensure that the contractual terms and conditions are being carried out and desired service levels are being achieved. Communication styles determine the quality of information exchanged by the partners and has a direct influence on the level of services and performance delivered to the client organization. Dent (2006) critiques the communication styles of clients and vendors in the IT outsourcing field and laments at the lack of open communication between parties. Dent (2006) suggests that trust and confidence issues can arise in such relationships unless vendors and clients resolve to share immediately all information that is material to the delivery of outsourcing services. Information as well as feedback should be exchanged openly and clearly without making half-hearted attempts at either. 3.2 Selection of Relationship Manager and Power Plays It is interesting to note the effect of the decision making center and intraorganizational power plays on the outcome of outsourcing decisions. Chakrabarty and Whitten (2011) examine the difference in the quality of outsourcing arrangements depending on the organizational groups making the decision. This factor may also need to be considered when assigning responsibility for maintaining relationships with vendors. According to Chakrabarty and Whitten (2011), the IT outsourcing arrangements tend to be more productive when the decision is made by IT executives compared to when the decision making is shared with business executives. This is understandable given the specialized knowledge of the IT staff compared with the competition for boardroom influence among business executives. Therefore, power plays should be ignored when assigning responsibility to IT executives for managing the outsourcing relationship with the vendor. It appears that relationships between the organization and the service provider are as challenging to manage as the relationships between the organization and its IT staff. Ranganathan and Outlay (2009) explain that the CIO bears the primary responsibility for informing and communicating with the employees during the transition phase. As a result, the information needs of the IT staff are met through a credible source. It is also important to treat the employees of the organization as well as those of the service provider brought in fairly. Therefore, the CIO should resist the urge to shift all the responsibility for managing the transition and helping employees adjust to the new environment to the human resource function. In fact, a healthy outsourcing relationship is based on fairness and sharing of information openly. Willcocks and Griffiths (2010) identify the need for identifying managers with the right mix of flexibility and leadership skills to help the outsourcing relationship get off the ground and towards high performance. They state that individual personality traits and working styles of managers on both sides of the relationship can make or break the relationship. Hence, it is essential that the relationship management responsibility be delegated to a manager who has the right temperament and skills to maintain a mutually beneficial relationship with the vendor. This becomes even more important in cases of offshore outsourcing. In offshore outsourcing, the relationship managers may find themselves interacting with people from diverse cultures and work ethics (Willcocks and Griffiths, 2010). As a result, they need to acquire skills and behaviours to achieve the required outcomes. It is important that the individual in charge of managing the outsourcing relationship with the vendor be able to perform multiple roles and functions. Willcocks and Griffiths (2010) list nine core roles that the middle manager needs to perform in order to maintain the IT outsourcing relationship. The relationship manager needs to possess leadership skills as well as technical skills so that he or she can integrate the IT services with the core business functions of the organization and trouble-shoot problems without waiting for the service provider to step in. An important issue that the relationship manager or project manager has to address is the transition from perform IT in-house to adapting to operational level IT tasks. He or she is also responsible for ensuring that the promised value is eventually derived from the outsourcing relationship. In order to ensure that the outsourcing relationship remain mutually beneficial, it is incumbent upon the client organization to evaluate each bid thoroughly. In particular, low supplier bids need to be assessed in detail to ascertain whether the bid is a profitable one for the vendor (Kern, Willcocks, and Van Heck, 2002). It is also important that both the vendor and client representatives are empowered to make the decisions about bidding and vendor selection. Flexibility has repeatedly emerged as one of the challenges in the outsourcing relationship management. To ensure flexibility, relationship managers must avoid the tendency to enter into fixed-price agreements. Because of the rapid pace of change in the IT industry, it may be necessary to revisit the service and payment terms from time to time. Managers should also avoid believing in a zero-sum game where the supplier is locked into a relationship that only benefits the client (Kern, Willcocks, and Van Heck, 2002). 3.3 Balancing Long-Term Collaboration with Innovation and Flexibility In order to create a healthy portfolio of vendors without losing the benefits of long-term collaboration, organizations may need to differentiate and rank vendors on the basis of performance and competencies. Poston, Kettinger and Simon (2009) have developed a ranking system where organizations can categorize vendors in terms of their ability to provide strategic, operational or tactical level services. Service providers can be placed in any of these categories based on their knowledge of the organization’s business activities, efficiency and reliability of service, price, level of trust and commitment, emergency responsiveness and transparency. This kind of strategy may be useful for organizations that have developed a network of IT outsourcing partners over several years enabling them to derive the maximum benefit from the core competency of each service provider. Managing vendor relationships is a crucial and continuous process of sustaining the outsourcing relationship. Once work has commenced, disagreements may arise about the exact nature and volume of work the outsourcing partner is expected to perform. Another challenge that needs to be addressed is the continued alignment and goal congruence between the two firms. The organization needs to develop competencies in making sure that the right partner for IT outsourcing is selected and that the relationship with the service provider is sustained over time. Ranganathan and Balaji (2007) explain that organizations need to develop global IS vendor management capabilities. They argue that organizations should have a standard method for selecting vendors so that bias and discrimination are eliminated in the selection process. Objective criteria such as technical facilities, flexibility and work practices should be evaluated before selecting an IT outsourcing partner. Once the vendor has been selected, Ranganathan and Balaji (2007) argue that organizations should accommodate the interests of both parties at the stage of drawing up the service agreement. Standard contracts may be developed which should then be customized according to the particular situation. This eliminates the risk of granting non-competitive terms to a particular vendor over others. The main challenge with long-term consequences is to keep the efforts of both parties aligned towards the same goal and to resolve any disagreements amicably. Ranganathan and Balaji (2007) suggest that joint committees, task forces and teams should be set up and regular meetings should be held to discuss emerging problems. A number of challenges arise from the peculiar nature of IT relationships with third parties. McFarlan and Nolan (1995) explain that contracts for IT outsourcing arrangements tend to be made to cover a long period of time. This feature of the relationship can be a cause of stress as technology changes are much more frequent and can induce feelings of loss and being in a poor bargain by either party. McFarlan and Nolan (1995) also assert that a mutually beneficial client-vendor relationship is the most important determinant of outsourcing success. Hence, it is important to ensure that the payment streams are scheduled in a way that they become aligned with the benefits accruing to the client. Negotiations are still necessary to shape the relationship according to the evolving needs of the client and the vendor (McFarlan and Nolan, 1995). McFarlan and Nolan (1995) also state that the CIO has an important role to play in managing the relationship with the outsourcing partner. Although tactical level line-related IT functions are outsourced to vendors, the CIO is still responsible for planning and anticipating the future IT needs of the organization and negotiating theory provision with the vendor. Key areas where the CIO is required to play an active role are contract management, architecture planning and evaluating emerging technologies which can provide competitive advantage to the organization. Benkel, Andrews and Tibbets (2012) state that organizations outsourcing their IT function should ensure that their service level agreements (SLAs) contain room for flexibility and innovation over time. Often firms find themselves locked into rigid contractual terms despite the ability of the service provider to provide innovative services. This is why the importance of the negotiation phase should not be underestimated and vendor management professionals should prepare well for the negotiations with vendors. Another related issue which emerges during the negotiation stage if the organization representative is not well-prepared is the likelihood of committing errors or accepting unfavorable terms because of time pressures (Benkel, Andrews and Tibbets, 2012). In such a case, it may become extremely difficult for firms to request service updates under the existing contract. 3.4 Human Resource Issues Research shows that it may be important to adjust to new working arrangements with suppliers. In some cases, these new arrangements may create unique human resource issues for the organization. Ranganathan and Outlay (2009) identify some of the issues that may arise as a result of IT sourcing relationships. In some situations the organization may decide to place its IT employees at the service provider organization. Alternatively, the employees of the supplier service provider may be brought in to the organization. Ranganathan and Outlay (2009) explain that such relationships are based on clear and unambiguous negotiation of salary and benefits terms between client and service provider, accommodation of employees in appropriate teams and comprehensive orientation and accommodation into the organization. 4. Conclusion Competitive advantage and cost savings emerge as the most common reasons for organizations’ decision to outsource their IT function. The lack of adequate IT resources or the lack of skills to use IT resources for competitive advantage motivates organizations to leverage the resources and skills of a third party service provider. In order to obtain such benefits from the relationship, it is essential that organizations select the right partner so that performance issues do not arise in future and when they do, they are resolved smoothly. Open communication and trust-building behaviours need to be demonstrated both at the time of drafting the agreement and during the execution phase. Joint teams and committees should be created to identify emerging problems and opportunities and take concerted action immediately. Through these measures, organizations can take their relationships with IT outsourcing partners to a level of strategic partnership and collaboration. 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