The Realities of IT Outsourcing 101

By Jodi Mardesich

For more than a decade, public and private organizations have considered outsourcing some or all IT functions as a viable option. A recent Gartner report estimated that worldwide spending on IT outsourcing will rise from $191 billion in 2004 to $267 billion by 2009.

It's no wonder outsourcing is so appealing: organizations that outsource successfully save in the double digits by offloading IT projects to outside firms, often located offshore, where labor is less expensive. When outsourcing goes well, an organization can improve operations by hiring firms with expertise in an area that the organization may lack; in addition, the organization can find gains in strategic areas of business when they're freed up to focus on core competencies.

Despite these promises, the reality of outsourcing can be quite different. Half of all contracts signed between 2000 and 2004 won't meet expectations, according to Gartner analysts Linda Cohen and Allie Young, authors of Multisourcing: Moving Beyond Outsourcing to Achieve Growth and Agility. Outsourcing has worked so well for some organizations that they have entered into dozens or hundreds of contracts. However, Cohen and Young warn in their book that in the fever to outsource more and more projects and functions, companies are outsourcing compulsively, often without appropriate planning or systems in place for proper governance.

"As more and more functions are outsourced, integrating and managing a portfolio of service providers is becoming more difficult -- and is causing significant service disruptions in many organizations," Cohen and Young write. These difficulties underscore the need for "multisourcing," defined by Cohen and Young as "a new operational model that obtains business services from multiple sources inside and outside corporate walls, to obtain the best business outcomes." CIOs need to stop thinking of outsourcing in and of itself, and adopt a more holistic and strategic approach to sourcing as a whole, they say.

Identifying problems

According to Cohen and Young, problems with IT outsourcing typically fall into three categories: miscommunication, governance failure, and poor coordination.

• Miscommunication   Communication breakdowns between divisions in an organization can undermine outsourcing projects. CIOs must gain the trust of other C-level executives in order to get advance warning of mergers or acquisitions. In addition, projects in one division of the company may have an impact on another division's outsourcing plans, so coordination of all outsourcing deals can prevent overlapping or competing projects from negatively influencing each other.
• Governance failure   Governance is an ongoing process of managing and monitoring the project. When problems occur, organizations often blame the service provider, but in many cases the problems are caused by the immaturity of the organization's sourcing practices. "Strengthen your operation before you outsource," advises Paul Roehrig, Ph.D., a consulting analyst with Forrester Research.
• Poor coordination   Outsourcing can't be done in a vacuum. Projects will influence other initiatives within a corporation, so coordination between departments or projects is imperative. Measuring the success or failure of a project should take into account the state of the market and similar initiatives outside the company, as well. Cohen and Young cite a global petrochemical company that seemed to be successful at outsourcing until it compared its costs for services to market rates. Among 500 outsourcing contracts, the company was paying on average 20% more than market rates because the outsourcing projects did not require externally benchmarked pricing.

Making outsourcing work

By understanding why outsourcing so often fails, CIOs can put management and tracking strategies into place to ensure they don't become outsourcing casualties.

• Begin with research   "Executives are used to being in charge and having answers, so outsourcing for the first time can be disorienting," Roehrig says. CIOs should start by educating themselves and their team about their options. "Use this primer as a guide to deeper investigation tied to your specific business goals and environment," Roehrig says.
• Have a strategy   With the complexity of having multiple outsourcing relationships and the rapid changes in business needs, organizations must have a strategy for how they will use sourcing to meet long-term goals, Cohen and Young say. "You will never achieve optimal performance without a well-planned and integrated sourcing strategy."
• Strengthen internal operations   Roehrig advises strengthening internal operations before outsourcing. "Outsourcing can help improve operational control, but the chances of success are increased if the services to be handed over have solid measures and operational process control," he says. "To the extent possible, continue to drive improvements in the existing delivery environment. Don't put this on hold."

Managing the relationships

Outsourcing arrangements are ongoing relationships, not one-time transactions, Cohen and Young say. And Roehrig warns CIOs against thinking of outsourcing as a big procurement deal.

"A large IT or BPO [business process outsourcing] outsourcing deal is much more intimate than a procurement contract," he says. "The complexity, scope, duration, and business risk of an outsourcing deal dwarf most procurement contracts. Don't let yourself or your teams treat this like a contract for parts or labor."

A collaborative program management system with outsourcers can prevent failure, Roehrig says. A collaborative program management system includes a defined tool, process, and capability framework to manage the complexity of transitions and ongoing management. It raises visibility of program status, issues, and risks, reporting status and milestones along the way. Roehrig believes that having such a program in place can help to build a community of trust between the supplier and the customer. Several technology solutions from various vendors focus on different ways of managing collaboration. These include virtual program collaboration environments, collaborative work-sharing and online meeting systems, knowledge management repositories, and project management software. Companies are also advised to ensure outsourcers are compliant with the Sarbanes-Oxley Act, because liability for reporting accuracy extends to outsourcers. Section 404 of the Act requires internal controls that can be audited by a third party.  IT outsourcing will continue to grow in popularity, but needs to be better managed if companies are to achieve their objectives of saving money, focusing on their core competencies, and leaving IT to the IT experts. Think years ahead, not just about short-term financial gains. Roehrig compares it to preparing for a marathon, not a sprint.

"Doing an outsourcing deal takes stamina and persistence over a fairly long period of time that can sometimes be compressed, but usually with increased risk, he says.

Jodi Mardesich writes about business and is a former staff writer for Fortune.