Is outsourcing Information Technology Services an Effective Means of Reducing a Company's Overhead Expenses - Coursework Example

Executive Summary Information Technology service outsourcing is not a new phenomenon and is based on the assumption that the external service provider delivers the service faster, better and at a cost lower than what the enterprise can achieve by itself. By contracting out processes, the organization may achieve economies of scale, lower labor costs, enjoy more favorable payment terms and have a better cash flow position. However, an organization would have achieved success and effectively reduce overheads if it can offer product differentiation, reduce costs, maintain efficient supplier relationships, communicate directly with customers, if it can maintain flexible manufacturing to suit individual customer needs. Dell had a unique business model and was the pioneer in selling computers through their website. They did manage to maintain direct customer contact and eliminate overhead through elimination of intermediaries, through maintaining low inventory, low finished stocks, and their outsourcing customer support and service. However, the reduced overheads can be eroded, as in the case of Dell, when they had to suffer damaged reputation and cash expenditure to restore its position. This was despite their strategy to outsource only subassemblies and have control over the final test and assembly. There was misalignment between the organizational goals and its long-term strategy. IT outsourcing must necessarily be aligned with business goals and have a long-term perspective. Introduction Outsourcing of Information Technology (IT) services has been in practice by organizations for several reasons. Organizations typically delegate their non-core functions to outside service providers on the assumption that the external service provider delivers the service faster, better and at a cost lower than what the enterprise can achieve by itself (Young, 2010). Business solutions are becoming customized and hence the service provider can employ standardized technology which results in lower costs. A manufacturer may perform the same business process at multiple locations but a service provider could perform the same process at a single location and deliver the service at multiple locations. By thus contracting out processes, the organization may achieve economies of scale, lower labor costs, enjoy more favorable payment terms and have a better cash flow position. However, an organization would have achieved success and effectively reduce overheads if it can offer product differentiation, reduce costs, maintain efficient supplier relationships, communicate directly with customers, if it can maintain flexible manufacturing to suit individual customer needs, if it has a culture for keeping costs contained while maintaining efficiency. Overhead expenses could include expenses that are not attributed to any specific business activity but nevertheless necessary for businesses to function. These could differ across sectors and organizations but include expenses such as rent, utilities, and insurance. Based on the case of Dell Inc, this paper would evaluate the extent to which outsourcing has changed the effectiveness in reducing overhead expenses. Dell – company strategy Dell has been one of the pioneers in mass customization and a premier supplier of technology for internet infrastructure. They are widely recognized for their built-to-order (BOT) business model. Customers can order customized orders and only when the order has been placed the system is built as per customer specifications. Dell does not stock any inputs but has an extranet that connects it with its suppliers. Dell has a network of 200 suppliers and each of them can access the secure extranet and view Dell’s report on production plan, material demand, material quality, negotiated and forecasted cost reports (Pollard, Chuo & Lee, 2008). Dell outsources subassemblies and standard and non-configurable components. To maintain quality dell retains the key final assembly and configuration processes. It ties up for essential components with suppliers with global capabilities such as Sony, Intel, IBM etc. for non-essential items it enters into contact with suppliers from low-cost countries in Asia. Uniqueness about the Dell business model is its strategy to sell computers directly to the end-users thereby eliminating the distributors or retailers (Pollard, Chuo & Lee, 2008). The company gains through this strategy of distribution as it helps reduce the costs paid to intermediaries, it avoids distortion of information through intermediaries, and most importantly, there is zero finished goods inventory and zero inventory carrying cost. Through the EDI system they are able to restrict four-day inventory level which is among the most cost effective for any company (Alkelabi et al, 2006). Its inventory carrying cost reduction is a very significant part of overhead expenses because carrying inventory would also imply insurance premium for inventory. Again, since its shipping takes place immediately, it has virtually no finished product stocking costs involved as well. The third significant cost reduction is the low risk of bad debts. Dell does not have to encash the sale bills through banks and then run into bad debts. With the use of credit cards and the use of the website to place orders, bad debts are virtually zero and this also keeps its cash flow intact. Their strategy is customer-focused as the customers gain when they can connect directly with the company. As far as communication with customers is concerned, Dell establishes dialogue to help customers articulate their needs and then develops customized outputs to meet these needs (Pollard, Chuo & Lee, 2008). Dell maintains a single source partnership with Intel which has enabled it to contain costs and have consistent supplies. However, this strategy also limits the customer choice (Alkelabi et al, 2006). Most often the outsourcing decision is based on where overhead costs can be saved without focusing on the long-term benefits of the organization (Mclvor, 2007). Sometimes organizations outsource processes that are critical to competitive advantage and over time they relinquish the important knowledge sets. Dell has outsourced its product design to specialist design companies. The majority of the manufacturing is outsourced while it has control over the final assembly, test and customization of the end product to customer requirements. This is because Dell believes that many of the processes create little value for the customers and can easily be outsourced. It thus focuses on sourcing relevant technologies and developing strong collaborative relationships. Discussion on Dell’s IT outsourcing strategy Outsourcing refers to contracting with an outside entity to form processes for a firm. This can be in the case of manufacturing of products or even in contracting out services. In the IT and software industry the client firms retains a higher level of control as it transfers some of the activities to the service provider (Javalgi et al, 2009). However, the selection of the service provider is critical; it should be that which can be trusted and that which offers the best solutions to fulfill client needs. Dell however, in its effort to cut overheads, and to remain competitive, encountered mistakes in supplier selection. Quality difficulties arose in its PC lines made by some of the company’s contract manufacturers. This resulted in buyers declining to buy Dell laptops. Dell had to then take charge of $40 million to write off the laptop line and suspend sales until it could redesign the model and get it back into the market place (Thompson & Gamble, 2008). Thus, when outsourcing IT function, technology and criticality have to be focused upon. While Dell did make profits as the low-cost vendor, the profits and cost savings in overheads can be written off with damages such as lack of adherence to quality by suppliers. Savings in costs can also be eroded due to lack of cooperation from other organizations and bureaucracy within the organization. Dell’s supply chain efficiency eroded between 2003 and 2006 when it had to maintain five-day inventory. This occurs when there is misalignment between its procurement and supply chain activities and production line. They did bring down the inventory cycle to four days by 2007 but since their quality control was not perfect they incurred $307 million in 2008 (Thompson & Gamble, 2008). In a bid to reduce their costs, Dell also compromised with the customer service centers. At the global level they had just 25 centers and these too were mostly engaged in providing technical support or in repairs. To further reduce their overheads, they moved their service support to low-wage countries. As service issues came up, adverse publicity led to damaged reputation and brand image. These not just impact the overall efficiency and success of the organization, the purpose of such outsourcing too is not achieved, as the company ends up paying compensation. For successful IT outsourcing collaborations have to be effective. The IT strategies have to be aligned with business goals; the priorities have to be determined and the service levels have to be defined. Organizations fail to effectively translate their outsourcing strategies to achieve the synergies. Dell lacks in innovation although it started as pioneers with an excellent business model. However, the PC industry is facing wide competition globally and to maintain profits, the focus is on reducing costs, thereby reducing the differentiation among competitors (Alkelabi et al, 2006). Dell is thus losing its competitive edge in critical business segments. Dell’s strategy for success has been to focus on product customization and superior relations with suppliers but these have been diluted in the past five years. Declining customer service has resulted in dilution of brand value. Dell leverages technology created by other suppliers and hence is unable to serve all the market needs as it has limited vendors in its supply chain. Conclusion Information Technology services outsourcing is not a new phenomenon but its effectiveness depends on whether the organization has been able to achieve the synergies it aimed to. Dell could initially reduce its overheads by outsourcing and contracting with external suppliers. Its business model fetched it immense success but over time misalignment occurred. Dell could not sustain the success and effectiveness as it lacked innovation. It leveraged technology through external service providers and hence could not maintain product differentiation. It could maintain direct contact with customers before, during and after the order is placed through their website. It also managed to establish excellent network with its suppliers and maintain flexible manufacturing to suit individual customer needs. Dell also achieved economies of scale when it outsourced most its component products while retaining the final test and assembly in-house. However, in its bid to contain overhead costs, the company compromised on customer service and support. There was misalignment between the organizational goals and its long-term strategy. It could not have control over quality of processes that were outsourced and the company had to pay heavily to restore its market position. Thus, IT outsourcing must necessarily be aligned with business goals and have a long-term perspective. References Alkelabi, K. et al. (2006). STRATEGY ANALYSES AND RECOMMENDATIONS FOR DELL, INC. Retrieved from http://www.scribd.com/doc/18080386/Strategy-Analyses-and-Recommendations-for-Dell Javalgi, R.R.G. et al, (2009). Outsourcing to emerging markets: Theoretical perspectives and policy implications. Journal of International Management, 15, 156-168 Mclvor, R. (2008). What is the right outsourcing strategy for your process? European Management Journal, 26, 24-34 Pollard, D., Chuo, S., & Lee, B. (2008). Strategies For Mass Customization. Journal of Business & Economics Research, 6 (7), 77-86. Thompson, A.A., & Gamble, J.E. (2008). Dell Inc. in 2008: Can it overtake Hewlett-Packard as the Worldwide Leader in Personal Computers? Young, J.T. (2010). Achieving Real Results from IT Outsourcing. Retrieved from http://www.perotsystems.com/MediaRoom/Library/WhitePaper_AchievingResultsFromITOutsourcing.pdf Read More