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When Eastman Kodak turned over the bulk of its IT operations to three outsourcing partners in 1989, outsourcing was a $4 billion a year business.1 Today, that number has grown to nearly $40 billion a year, according to the estimates of industry watchers Frost & Sullivan. Following Kodak’s example, various companies such as Continental Bank, General Dynamics, Continental Airlines, and National Car Rental opted to dismantle internal IT departments by transferring IT employees, facilities, hardware leases, and software licenses to third-party vendors for seven- to ten-year periods.2 But while such high-profile deals are continually reported — most recently, involving Xerox, Delta, and British Aerospace — a different, more typical pattern has been developing. The growth of IT outsourcing is increasingly based on what we call “selective sourcing,” characterized by short-term contracts of less than five years for specific activities. Selective sourcing meets customers’ needs while minimizing the risks associated with total outsourcing approaches.
Companies outsource IT for many reasons, ranging from its high profile and current popularity to cost pressures from competition and the economic recession.3 However, industry watchers attribute the growth of the IT outsourcing market to two main phenomena. First, interest in IT outsourcing largely results from a shift in business strategy. Many companies have abandoned their diversification strategies — once pursued to mediate risk — to focus on core competences.4 As a result, IT has come under scrutiny. Senior executives frequently view the entire IT function as a noncore activity and reason that IT service vendors have the economies of scale and technical expertise to provide services more efficiently than do internal IT departments.5
Second, uncertainty about IT’s value is another reason for the growth of outsourcing. In many companies, senior executives perceive that IT has failed to deliver the promise of competitive advantage propagated in the 1980s.6 Consequently, many senior executives view IT as a necessary cost to be minimized. The CEO of a U.S. conglomerate of petroleum, natural gas, and chemicals expressed his frustration with IT:
All we see is this amount of money that we have to write a check for every year. Where is the benefit? IS says, “Well, we process data faster than we did last year.&
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1. L. Applegate and R. Montealegre, “Eastman Kodak Co.: Managing Information Systems through Strategic Alliances” (Boston: Harvard Business School, Case 9-192-030, 1991);
L. Loh and N. Venkatraman, “Diffusion of Information Technology Outsourcing: Influence Sources and the Kodak Effect,” Information Systems Research, volume 3, December 1992, pp. 334–358; and
L. Willcocks and G. Fitzgerald, A Business Guide to IT Outsourcing: A Study of European Best Practice in the Selection, Management, and Use of External IT Services (London: Business Intelligence, 1994).
2. J. Ambrosio, “Outsourcing at Southland: Best of Times, Worst of Times,” Computerworld, volume 25, 25 March 1991, p. 83;
G. Anthes, “Perot Wins 10-year Outsourcing Deal,” Computerworld, volume 25, 8 April 1991, p. 96;
R. Hamilton, “Kendall Outsources IS Chief,” Computerworld, volume 23, 13 November 1989, pp. 1, 4; and
M. Hopper, “Rattling SABRE — New Ways to Compete on Information,” Harvard Business Review, volume 68, May–June 1990, pp. 118–125.
3. M. Lacity, R. Hirschheim, and L. Willcocks, “Realizing Outsourcing Expectations: Incredible Expectations, Credible Outcomes,” Journal of Information Systems Management, volume 11, Fall 1994, pp. 7–18.
4. C.K. Prahalad and G. Hamel, “The Core Competence of the Corporation,” Harvard Business Review, volume 63, May–June 1990, pp. 79–91.
5. M. Lacity and R. Hirschheim, Information Systems Outsourcing: Myths, Metaphors, and Realities (Chichester, England: Wiley, 1993); and
M. Lacity and R. Hirschheim, Beyond the Information Systems Out-sourcing Bandwagon (Chichester: England: Wiley, 1995).
6. D. Feeny and B. Ives, “In Search of Sustainability: Reaping Long-term Advantage from Investments in Information Technology,” Journal of Management Information Systems, volume 7, Summer 1990, pp. 27–46; and
W. Kettinger, V. Grover, S. Guha, and A. Segars, “Strategic Information Systems Revisited: A Study in Sustainability and Performance,” MIS Quarterly, volume 18, March 1994, pp. 31–58.
7. M. Mehler, “The Age of the Megacontract,” InformationWeek, 13 July 1992, pp. 42–45.
8. P. Krass, “The Dollars and Sense of Outsourcing,” Information Week, 26 February 1990, pp. 26–31;
J. Rochester and D. Douglas, eds., “Taking an Objective Look at Out-sourcing,” I/S Analyzer, volume 28, September 1990, pp. 1–18; and Hamilton (1989).
9. Willcocks and Fitzgerald (1994).
10. These numbers reduce to 13 percent of current IT budgets and 25 percent of predicted 1998 budgets when total outsourcing deals are excluded from the analysis.
11. R. Yin, Case Study Research, Design, and Methods (Beverly Hills, California: Sage Publications, 1984).
12. L. Applegate, “Managing in an Information Age: Transforming the Organization for the 1990s” (North Holland, Amsterdam: Transforming Organizations with Information Technology, Proceedings of the IFIP Conference on Information Technology and New Emergent Forms of Organizations, 1994), pp. 15–93; and
A. Pettigrew, ed., The Management of Strategic Change (Oxford: Blackwell, 1987).
13. It was too soon to definitively determine the financial outcome of seven of the total outsourcing decisions, although participants reported unexpected excess fees and hidden costs; only two total outsourcing decisions were reported as successes.
14. R. Benjamin and J. Blunt, “Critical IT Issues: The Next Ten Years,” Sloan Management Review, volume 33, Summer 1992, pp. 7–19.
15. T. Barron, “Some New Results in Testing for Economies of Scale in Computing,” Decision Support Systems, volume 8, issue 4 1992, pp. 405–429.
16. F.W. McFarlan and R.L. Nolan, “How to Manage an IT Outsourcing Alliance,” Sloan Management Review, volume 36, Winter 1995, pp. 9–23.
17. E. Clemons and M. Row, “McKesson Drug Company,” Journal of Management Information Systems, volume 5, Summer 1988, pp. 36–50;
D. Copeland and J. McKenney, “Airline Reservation Systems: Lessons from History,” MIS Quarterly, volume 12, September, 1988, pp. 353–370; and
N. Venkatraman and J. Short, “Strategies for Electronic Integration: From Order-Entry to Value-Added Partnerships at Baxter” (Cambridge: MIT Sloan School of Management, working paper, 1990).
18. D. Feeny, M. Earl, and B. Edwards, “Organizational Arrangements for IS: Roles of Users and IS Specialists,” in M. Earl, ed., Information Management: The Organizational Dimension (Oxford: Oxford University Press, forthcoming).
19. J.C. Henderson, “Plugging into Strategic Partnerships: The Critical IS Connection,” Sloan Management Review, volume 31, Spring 1990, pp. 7–18; and
McFarlan and Nolan (1995).
20. For a more detailed discussion, with examples, see:
M. Lacity, L. Willcocks, and D. Feeny, “IT Outsourcing — Maximize Flexibility and Control,” Harvard Business Review, volume 73, May–June 1995, pp. 84–93.