The hype surrounding application service providers (ASPs) has once again focused attention on the pros and cons of offloading IT activities on to an external provider. The accumulated wisdom gleaned over the past 30 years from one form of outsourcing or another means there is now no excuse for getting it wrong.
David Thorpe, vice-president of global operations for outsourcer EDS, says the golden rule for entering into a deal is that the outsourcer should be able to do it better, cheaper or faster than you can in-house.
If an outsourcer can meet these criteria, it is then possible to outsource pretty much anything, says David Alexander, director of strategy and marketing at services company Northgate Information Solutions (formerly MDIS). However, he believes you should only outsource things you are comfortable outsourcing, and he warns that the one area you must retain control over is your strategy. "You certainly can't get rid of responsibility for your strategy and how the business uses your systems," he says.
If you want your outsourcing deal to be successful, you definitely should not use it to sweep problems under the carpet, warns Eileen Birge, research director at management consultancy Concours. "Successful companies are good at establishing a baseline of where they are today and understanding where the headaches are occurring and why. They are then able to determine what is a reasonable goal for them to achieve with an outsourcer," she explains.
A key decision is to decide what form of outsourcing is right for your company. Over the years, a number of models have been developed. In many respects, the latest - the ASP approach - is just a recasting of the earliest bureau services where clients shared time on an expensive mainframe. The major difference in the ASP model is that, rather than having to put up with a vanilla implementation of the bureau's software, applications are now configured to meet clients' needs. This allows more sophisticated applications to be piped in.
With bureau companies building up expertise in datacentre operations during the 1970s, the next step was the move to facilities management in the 1980s. Typically, firms would hand over day-to-day operation of their hardware but keep aspects such as application management or user support in-house. The late 1980s and early 1990s saw a move to total outsourcing deals, where organisations handed over their entire IT departments to outsourcers, often for upto 10 years.
Thorpe points out that this move was frequently driven by the management philosophy of the early 1990s to concentrate on core business. The same philosophy led to a boom in outsourcing of whole business processes.
This "core business" philosophy has become somewhat discredited as companies now recognise that information systems may actually be a key competitive weapon in achieving business success. At the same time, difficulties have cropped up in a number of total outsourcing deals as they have matured, and this has also contributed to this approach falling out of favour. For example, EDS launched a law suit last year against one of its leading clients, Xerox, over a contract clause. At the time it was signed, the 10-year, £2bn deal had been hailed as a model development.
The basic problem, says Daryl Howe, director and founder of independent outsourcing consultancy Quantum Plus, is that it is naive to expect that one company can solve all your problems. "The outsourcer just cannot be the best across the whole spectrum. Also, the supplier and customer have different objectives, and you can't just hand it all over and trust the supplier to look after all your objectives," he says.
The perception that it is difficult to get good service across all aspects of a total outsourcing deal and that you risk becoming over-dependent on the supplier if you outsource everything have led companies to become more selective about what they outsource and to work with multiple partners, each specialising in a particular area. The major drawback of this approach is that it increases the management burden and costs on the client side.
All these traditional outsourcing contracts are based on service level agreements (SLAs) that describe the rewards and penalties for performance against clearly articulated targets. A more recent trend is for partnership and equity arrangements, where the outsourcer may take a stake in the client or where there is a much stronger element of risk and reward on both sides. Here, the outsourcer uses its expertise and initiative to help the client drive its business forward.
However, John Cooper, European managing director of management consultancy Concours, is cautious about strategic partnerships and joint ventures between user organisations and IT companies. "The user company doesn't want to lose complete control, but you have to ask what it is doing running an outsourcing business," he says. "Problems will be inevitable if the joint venture organisation starts having business objectives which are not fully aligned with those of the client organisation."
Following a more conventional tack, the latest development is externalisation: contracting for managed services for systems that have never been run in-house. The exponents of this approach are dotcoms, but traditional firms are choosing to implement complex new systems, such as enterprise resource planning applications, through the ASP model.
This renewed interest in outsourcing might suggest that the in-house IT department is doomed. However, there are a number of roles which can never be taken away from the in-house team. These include managing suppliers and monitoring service delivery, advising the business on how developments in IT and the innovative use of IT by others could be applied to develop the business, and interpreting the needs of business managers for new systems and then sourcing these systems, perhaps through new contracts with external providers.
As a result, suggests Ian Leask, a consultant with benchmarking specialist Compass Management Consulting, the IT department of the future will no longer be full of technical specialists but stuffed with commercial planners, business analysts and contract managers. They will ensure the organisation gets what it wants from outsourcing deals, rather than what outsourcers want to supply because it would be better for their bottom lines.
Leask adds that such a team also has to act as a buffer between the outsourcer and business managers, to ensure that any changes to the contract to meet new business needs are implemented in a controlled way. For example, they may want to ensure new systems are based on standard technologies to prevent costs from escalating.
However, Leask says this essentially commercial team will still need both a technical background and a good understanding of their company's business environment. For example, it should be able to take an informed view on why four out of five companies in their vertical sector are using a particular supplier's hardware and decide whether it would be a valid approach for its own company.
"The team does not need real in-depth technical knowledge, but it does have to understand whether particular technologies can add value to the business," Leask explains. "This will then allow team members to discuss with the outsourcer how it should develop its own infrastructure to support the client in the future."
In fact, the importance of retaining the right skills in-house cannot be overemphasised. Research conducted by management consultancy Concours found that poor supplier management was a major factor in the failure of outsourcing deals, but three-quarters of organisations did not recognise supplier management as a skill, while almost all of them underestimated the resources needed to monitor performance and adherence to contracts.
Beyond that, Howe believes there is definitely a place for an in-house technical team when it comes to delivering those elements of the IT strategy that bring competitive advantage. He says outsourcing should be reserved for established, routine processes such as helpdesks, application support, legacy systems and payroll and personnel.
"Where outsourcing struggles and where there is a role for the in-house team is where there is a rapidly changing situation or one that requires complex judgement of priorities. If you try to outsource things that are evolving and non-routine, it can be hard to determine SLAs, to measure performance and to price them," he says.
However, trying to convince your business colleagues that they still need an in-house IT team may not prove to be easy.
Next week, we look at some tactics to keep IT in-house and profile a company that has brought its IT back in-house
Ingredients for a model outsourcing contract
Case study: Southern Pacific Mortgage links with bureau/ASP
Southern Pacific Mortgage (SPML) did not want to be saddled with the hassles of implementing systems or building up and managing an IT team - and it wanted to avoid the up-front capital costs of investing in IT.
A deal with the application service provider (ASP) arm of Lynx Financial Systems gives it access to Lynx's workflow-based Summit system, which manages its mortgage application process, while also allowing it to offload the day-to-day wrangles of running systems.
SPML is a mortgage lender specialising in "non-conforming" mortgages for borrowers who are unable to obtain mortgages from high-street banks or building societies. The company prides itself on offering good service and fast turnaround to intermediaries that package together the necessary documents on behalf of would-be borrowers and submit them to SPML for a decision.
"We need a system to provide back-up, but we don't want the development and running of that system to become a full-time job," explains Angela Davies, director of operations at SPML.
"Our skills are handling credit, and being able to make decisions based on prudent lending policies, bearing in mind the profile of our customers. We want our managers to be able to focus on those core activities and to rely on experts to provide IT services to us," she points out.
Since January, SPML has been using a system that is piped in to its offices in Kensington, central London, over a leased line from Lynx's datacentre in Bedfordshire. The deal with Lynx follows a bureau arrangement with third-party mortgage administrator Home Loan Management. The advantage of Lynx's ASP offering is that SPML no longer has to put up with a standard, inflexible solution but can tailor the Summit system to match its processes and business methods.
Davies points out that SPML has service agreements with Lynx not only for ongoing operations and helpdesk support but also for application development.
"If we want to be innovative in our business and do something different with the system, we can get those changes delivered within an agreed timescale. We have the same control as if we had an in-house IT department," she says.
Case study: Towry Law ventures into a strategic partnership with CMG
Partnership is an overused word in the outsourcing industry. But a strategic business partnership between leading independent financial adviser (IFA) Towry Law and IT services group CMG appears to be delivering benefits to both sides. Under the 10-year deal, worth £17m, Towry Law has been able to pursue an aggressive growth strategy, successfully identifying, acquiring and integrating five companies in less than a year. It has also relocated the company's offices while completely overhauling its systems from front to back in the two years since the deal was signed.
"We certainly couldn't have achieved that without the kind of relationship we have with CMG," says Keith Webb, Towry Law's chief operating officer.
Established 40 years ago, by 1998 Towry Law employed 250 staff, boasted a turnover of £18m and had a strong brand name. However, it faced two major business challenges: the need to deal with enhanced regulations imposed by industry regulators and the need to grow both organically and through acquisitions. Both of these challenges demanded investment in IT systems and infrastructure but, like other medium-sized companies, Towry Law couldn't afford the up-front investment costs.
From previous experience, Webb and his chief executive knew the solution could lie in working with an outsourcing partner. Yet Webb also wanted a depth of relationship that would give Towry Law a degree of visibility and commitment at board level within the outsourcer.
"We needed to identify a strategic partner whose business objectives would mirror ours," he explains. That led Towry Law to CMG, which had aspirations of its own to develop its business in the IFA market, having acquired an IFA system. CMG needed an IFA to work with it and act as its flagship. Towry Law could also help CMG develop its management consultancy business by broadening its contacts in major financial organisations beyond the IT department, through introductions to the senior decision-makers in companies whose financial products Towry Law distributes.
"If a financial product provider wants us to act as a distributor for its products, it will have to work with CMG as our technical partner," Webb explains. So the continued success of the deal advances the business strategies of both parties.
In practical terms, the outsourcing deal covers three elements:
While disputes between the two companies have so far been rare, there is a clear escalation path for serious issues which cannot be resolved easily. It requires CMG to bring in an independent team at its own expense to report to the Towry Law board. Towry Law has also created another safeguard against the risk that CMG might exploit its favoured position.
"Solely at my discretion, I can instruct one of an agreed shortlist of companies - which are not direct competitors of CMG - to review the entire relationship in terms of pricing and activity," Webb explains. "Should they report that CMG has done anything which is detrimental to our ability to compete, CMG will be in breach of the contract."
Is outsourcing the hero or villain of IT departments?
Director of strategy and marketing, Northgate Information Solutions
"Outsourcing should be a hero because it should free the in-house team to concentrate on value-adding activities and provide staff transferred to the outsourcer with a better career path, since they are now working for an organisation specialising in IT."
Managing consultant, Compass Management Consulting
"In some situations, outsourcing can be exactly the right thing to do but there are other situations where you shouldn't outsource. For instance, you should never think you can get rid of a problem by outsourcing, because all you will do is make it bigger."
Director of network and information systems management, University of Paisley
"Selective outsourcing can help reduce the stress on IT staff, broaden their career options by allowing them to apply their technical knowledge to managing suppliers rather than doing the job themselves, and help focus them back on to the core business requirements of their organisation."
Chief operating officer, Towry Law
"If outsourcing is used effectively, it can be the hero in that it can enable the company to deliver its commercial strategy. It's a villain if you try to use it for pure cost reduction, because no outsourcing deal results in absolute cost reduction in the long-term - and you will pay for it later."
Tips for successful outsourcing
Case study:University of Paisley picks selective outsourcing
A detailed cost/benefit analysis was the impetus for the University of Paisley to outsource management of its campus networks to communications solutions provider Milgo Solutions. Milgo is now responsible for four Nortel-based networks supporting 10,000 students and 1,000 staff. As well as providing considerable cost savings, the three-year, £150,000, deal will relieve pressure on busy staff, eliminate the hassles of recruiting and retaining network skills and should help the university raise its standard of service.
The deal with Milgo is part of a deliberate policy at the university to selectively outsource suitable activities to commercial partners. Working with external partners in this way is unusual in the higher education sector.
Tony Shaw, Paisley University's director of network and information systems management, ascribes this willingness to work with commercial partners to the commercial background of many of the IT staff at Paisley. He says this leads them to recognise that external partners can provide a more effective or efficient service in some areas.
However, Shaw is wary of outsourcing everything. "With desktop services, users in higher education are frequently arguing for variations from the norm. It's very hard to tie the desktop down to a core set of products. Consequently, desktop services would be difficult to outsource." He also feels that outsourcing selectively through a series of relatively small contracts, which can be defined accurately, minimises the risks associated with managing outsourcing deals. Finally, he points out, outsourcing contracts places a heavy demand on senior staff and outsourcing selectively reduces that workload to manageable chunks.
When creating the network management contract, Shaw bundled together a range of elements that formed a logical unit and that could be defined easily. These included network maintenance, installation and configuration management and remote support. But from the outset he intended to implement these services incrementally and he was open to suggestions from the outsourcer as to how operations might become even more effective.
"A primary objective was to find a supplier who could help us develop the network through best practice, including the intelligent use of network statistics. Milgo's remote management facilities and existing customer base convinced us they could," he says.
Prior to the Milgo deal, the university had already agreed an outsourcing contract with Telewest for its wide area network. This deal is successful but, Shaw admits, it has taught him a great deal about how to outsource. He is now looking for an Internet service provider to provide round-the-clock support for student e-mail and remote dial-in access services.