The economics of outsourcing

Outsourcing is not simply an economic panacea. How will core business be affected?

Outsourcing is not simply an economic panacea. How will core business be affected?

IT has embraced outsourcing in an all-or-nothing fashion, whereby work currently performed in-house is moved to third-party facility management (FM) companies. However, I wonder whether there is an adequate understanding of the economics and implications of outsourcing, and the differences between development and supplier management.

I believe that no company can afford to outsource its core business activities, which provide the opportunities for profit. For example, life insurance has core activities that include fund management, the generation and processing of new business, and the administration over many years of the business attracted.

Fund management delivers profit through the skills of company investors. New business and administration contribute through the relative efficiencies of these processes vis-…-vis competitors. IT contributes significantly to both of these.

Outsourcing has economic attractions because FM companies attract similar business from a number of clients, treating their work identically, and benefiting from economies of scale. This leads to savings for the client, but at the expense of a loss of competitive edge over rivals.

Companies cannot afford for this to happen with core activities, which contribute to the position and perception of the company within its market. The standardisation of processing that outsourcing engenders would constrain product and service development if core activity is outsourced.

A further concern is that an outsourcing decision might indicate a lack of appreciation of in-house skills, and that this will lead to a reduction in IT service quality after outsourcing.

IT staff are sometimes viewed solely in IT terms. In practice, many have significant experience with their company and their IT skills are supplemented by specific knowledge of products and services which the IT systems support. A properly managed in-house IT department should have an advantage over external companies because of this knowledge and the value it can bring to the business.

In the medium- to long-term, companies should not count on high levels of client-specific knowledge being present within an FM company. The relationship between the business and IT, in its outsourced form, must change particularly in areas of planning and specification. Flexibility and business response times will inevitably be affected.

The question of whether the outsourced IT facility will be capable of adequately supporting the business must be examined. Will the company as a whole be as capable of changing and reacting as it was before?

Outsourcing can be a solution for handling non-core, routine activities. But, if core business is outsourced and adequate experience at managing external suppliers does not exist, there may be problems due to a loss of control and responsiveness.

In the aftermath of the Hatfield train crash, it will be interesting to see if the apparent decline of Britain's railways under Railtrack's stewardship is in any way due to the management of outsourced core activities, and whether any of the above might have applied.

David Moore is principal consultant with LNW Consultancy

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