Strategic Intent for IT Outsourcing

Three objectives -- improving IS, enhancing business performance, and generating new revenue -- that can help a company assess outsourcing.

Eight years after Kodak energized the marketplace by outsourcing major components of its information systems (IS) function, the information technology (IT) out-sourcing services industry is booming. Industry analysts predict that the global market will grow from $86 billion in 1996 to more than $137 billion by 2001.1 Out-sourcing arrangements with contract revenues in the hundreds of millions of dollars, once considered large, are dwarfed by recent deals such as those signed by J.P. Morgan, Dupont, and Xerox Corporation for billions of dollars. As the market matures, numerous companies routinely outsource large components of their IS activities. A 1996 survey of 450 information systems executives in North America and Europe found that about 50 percent of the respondents were planning to engage in outsourcing during 1996, and another 25 percent were considering it.2

IT is central to business initiatives such as reengineering, knowledge management, the creation of electronic channels of distribution, and the development of digital business strategies.3 Why are companies outsourcing the activities of their IS departments at such an unprecedented rate when IT has never been more critical to business success?

The motivations for outsourcing are evolving from a primary focus on cost reduction to an emerging emphasis on improving business performance. The traditional rationale of vendor economies of scale and specialization is becoming less convincing. Companies such as Dupont, British Petroleum Exploration, Lufthansa, Swiss Bank Corporation, and J.P. Morgan, with well-run, innovative IS departments that are large enough to accrue the same scale and specialization benefits as a vendor, are nevertheless engaged in significant outsourcing deals. Furthermore, as the growing role and importance of information and communications technologies become widely recognized, companies frequently confront a wide disparity between the capabilities and skills necessary to realize the potential of these technologies and the reality of their own in-house technology capabilities and skills. IT outsourcing is playing an increasingly prominent role in strategies designed to close this gap.

While many companies still follow the traditional out-sourcing model, several innovators are developing new models. Some firms outsource for strategic, not tactical, reasons, to exploit more fully the business benefits of IT. They are pursuing entirely new roles for IT outsourcing and pioneering new paths for IT outsourcing relationships. Consider these examples:

When Xerox Corporation recognized the pressing need to extend IT’s contribution to critical business processes, outsourcing was a key component of its strategy.

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References

1. EDP Weekly, 15 September 1997, pp. 3–4.

2. CSC, “Critical Issues of Information Systems Management for 1996” (Cambridge, Massachusetts: CSC, March 1997), pp. 14–15.

3. See:

M. Hammer and J.A. Champy, Reengineering the Corporation (New York: Harper Business, 1993);

J.B. Quinn, J.J. Baruch, and K.A. Zien, “Software-Based Innovation,” Sloan Management Review, volume 37, Summer 1996, pp. 11–24;

J.F. Rayport and J. Sviokla, “Exploiting the Virtual Value Chain,” Harvard Business Review, volume 73, November–December 1995, pp. 75–85; and

CSC Index Foundation Report 113, “Forming and Performing a Digital Business Strategy” (Cambridge, Massachusetts: CSC Index, August 1997).

4. See:

R. Hirscheim and M. Lacity, “The IT Outsourcing Bandwagon,” Sloan Management Review, volume 34, Spring 1993, pp. 9–23;

M. Lacity, L. Willcocks, and D. Feeny, “IT Outsourcing: Maximize Flexibility and Control,”

Harvard Business Review, volume 73, May–June 1995, pp. 84–93; and

M. Earl, “The Risks of IT Outsourcing,” Sloan Management Review, volume 37, Spring 1996, pp. 26–32.

5. E. Fama and M. Jensen, “Separation of Ownership and Control,” Journal of Law and Economics, volume 26, June 1983, pp. 301–325.

6. W. McFarlan and R. Nolan, “How to Manage an IT Outsourcing Strategic Alliance,” Sloan Management Review, volume 36, Winter 1995, pp. 9–23.

7. John Cross, “IT Outsourcing: British Petroleum’s Competitive Approach,” Harvard Business Review, volume 73, May–June 1995, pp. 94–102.

8. P. Wallington, from presentation at the CSC Index Summit Working Session, Atlanta, Georgia, 13–14 February 1996.

9. B. Caldwell, “Outsourcing Megadeals: More Than 60 Huge Contracts Signed Since 1989 Prove They Work,” Information Week, number 552, 6 November 1995, p. 34(7).

10. See Quinn et al. (1996).

11. The length of the contract was recently reduced to ten years.

Acknowledgments

We thank all the sponsoring organizations of the CSC Foundation research program that participated in our research on outsourcing. We also want to acknowledge Anne Pappenheim for her immense help in writing this article and to thank the CSC Foundation Research Team for providing encouragement, inspiration, and challenge to our ideas. We also thank Microsoft for its NetMeeting product, without which we would still be writing this paper.