Major IT Outsourcing Risks and Solutions to Mitigate Them

Author: Managed Outsource

According to a study conducted by Accenture, the growth of IT outsourcing has been astounding since 2000 with the market valued at $152 billion then is expected to reach $325 billion in 2013. Earlier, the outsourcing contracts focused only on hardware, as for example, the icontracts initiated by Eastman Kodak Co. and General Dynamics. As companies started to migrate from mainframes to client/server and distributed computing, the practice of software development outsourcing gained relevance for competing successfully in the global IT market. The main factors that encouraged firms to contract out application development and management are:

  • Growth of insourcing (IS) budgets
  • Opportunity to downsize the IS function
  • Cost-cutting benefits
  • Enhanced business benefits
  • Reduced responsibilities for operating and maintaining legacy systems
  • Efficient facilities management services
  • Desire to focus on core business

Companies that outsource IT functions need to know how to implement outsourcing, manage contracts and relationships efficiently, and choose the right options. Outsourcing contracts are generally built on account of certain assumptions and involve several risks due to uncertainty about the future. The IT field is dynamic by nature and risks are high. Understanding the risks involved and implementing an efficient mitigation plan is the key to success. Let’s look at the major risks involved in outsourcing:

Weak Management

If a company chooses outsourcing after finding an IT task low on operational performance, it is very important that their IT executives know how to manage contracts and relationships with the outsourcing vendor. If the vendor learns the customer’s IT management is weak at the initial stage, they would consider it as a sign for conflict and dissatisfaction in the future. To avoid badly managed IT activity, the company need to have responsible and efficient IT managers.

Responsibilities of an IT Manager While Outsourcing

  • Enhance commercial and legal competences in the IT domain
  • Improve the management of vendor skills
  • Deal with changes that the vendor may implement such as change in platform, location or modus operandi
  • Deal with changes in the vendor’s personnel or organization

Lack of Specialized Staff

It is generally expected that the vendor IT company will have IT specialists and so outsourcing would improve efficiency. However, in reality, in many new firms, staff is inexperienced. Moreover, the customer’s employees may go to work with the vendor even in facilities management contracts with most established IT service businesses. Transferring IT staff to the vendor may be done with the aim to assure continuity of service and knowledge in the short run. But this may not happen if these employees are not reliable. Having smart personnel policies at the time the contract is signed can help reduce some of these risks.

Obsolete Technological Capabilities

While outsourcing with cost reduction in mind, the customer company may expect that the vendor would implement learning and technological change so that the benefits of cost reduction accrue also in the future. Even though the company can include these improvements in outsourcing contract at the beginning or negotiate at annual reviews, there is no guarantee that the vendor skills will get advanced. For example, if you outsource legacy systems, the vendor may not feel the need update technology and the market will be frozen in old technology. In the case of a large-scale contract, it is very difficult to find another vendor if you do not get expected results from the existing one.

Widespread Uncertainty with IT Business

There are several uncertainties with IT business - users may not certain about their needs, adopting new technology is challenging, and changes in business requirements and implementation is done on the basis of assumptions. If the system project management system demands no changes to specifications, rigid time and budget controls, the applications designed will not attain their full potential and can result in user-specialist conflict. It is therefore very important to avoid concrete (not changeable) contracts while outsourcing. Work to build in contract variation clauses, annual reviews, or short-term contracts if the vendor agrees. Of course, this flexibility could come with a cost (for example, short-term contracts may draw cost premiums). However, it is better to pay for this flexibility than specifying tight performance outsourcing contract and lose the business due to uncertainties which are inevitable.

Hidden Costs

Outsourcing should achieve the objective of cost reduction – if this is the goal. The customer company should ideally compare vendor costs with their current costs and prepare cost schedules for building technology and learning. However, they often stumble at estimating future possible cost savings and predicting technological discontinuities while outsourcing. They may underestimate set up costs (redeployment costs, relocation costs and more) and management costs (as companies rarely record management cost).

Absence of Organizational Learning

Organizational learning is very important, particularly in the case of application domain or software development. Business context and needs change quickly in this field. An application that has low value today can become strategic, core and high-value tomorrow. The vendor should be able to operate, enhance, or rebuild an application that is reclassified as strategic. Customers often try to reduce such risks by moving from a transactional relationship with the vendor to a more strategic partnership. But vendors may not trust such contracts as they may feel that ‘strategic’ means sharing uncertainties, but no better prices.

Reduced Innovative Capacity

An company should maintain its innovating capacity to exploit new developments evolve in this field for the sake of business. When a company outsources its IT services and down-sizes, its ability to innovate is reduced. External sourcing does not guarantee slack resources, organic and fluid organizational processes, and experimental and intrapreneurial competences which are necessary for innovation. Even if the vendor is ready to provide the customer with innovative ideas, it will need to pay extra in management costs for the search costs of the innovation – the costs of identifying and locating the people capable of translating an idea into an application and implementing it.

Dangerous Eternal Triangle

To resolve the issue of IT specialists and users not understanding each other, a post is created for business analyst /client manager/systems liaison officer. Though the idea is to smooth out conflicts between IT specialists and users and bring represent their interests to the other party, the liaison role usually results in more confusion, misunderstanding and conflict. In a major outsourcing program, the remaining IT people will act a conduit or consultants between the IT managers and outsourcing vendors. The company managers will demand they would like to work with the people who understand their work culture. The vendors will say they have to train their specialists in business and building organizational relationships. Meanwhile, the remaining IT people will be striving to add value to their work and sharpen their skills in project management, conflict resolution, teamwork and negotiation. While this learning process takes place, the IT organization may end up standing still.

Technological Indivisibility

It is better to think twice before outsourcing indivisible IT areas as it will result in much complexity. Let us consider the case of outsourcing integrated or interconnected information systems. Here, problems can occur at the interface between vendors and between the vendor’s domains and customer’s domain. Another example is outsourcing desktop service (normally no vendor will bid for a contract to manage desktop) which will involve personal computer service, software maintenance, user support, managing local area networks, hardware, operating systems and applications. If something goes wrong, it would be quite difficult to find out whether it is the fault of mainframe supplier, disk supplier, communication vendor or the customer itself. Indivisible areas are prone to complex interdependencies which cannot be handled efficiently with outsourcing.

Vague Focus

IT outsourcing usually focuses on the supply side (providing IT operations, service, training and development), not on the demand side (providing innovative application ideas, challenging effort in system implementation, delivery of IT benefits). Without a clear focus that covers all aspects of IT business, outsourcing cannot bring in sustainable business-added value or competitive advantage for either hardware or software development.

Effective Mitigation Strategies

Smart Sourcing

It can be quite risky to outsource information systems integral to business strategy, especially when IT operations are already efficient. Insourcing is the right option in this situation. If the business value of an application or technology is low and operational performance is considerably weak, outsourcing is the better option. This strategy is selective or smart sourcing which will help to segment the IT domain if its elements are not central to business strategy but important for operational performance.

Active Management of Outsourced Activities

A company’s big gains come from how effectively it manages its outsourced IT operations. The active management of IT involves identifying and implementing innovative uses of IT without causing supply-side issues and driving the attention of IS executives towards the deployment of IT to improve business revenue.