Risks and rewards of IT outsourcing and insourcing to an organisation

Tim Kelly

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IS6137

Word Count: 1,452

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Executive SummaryThe purpose of this research is to provide a detail summary of the risks and rewards for IS/IT outsourcing and IS/IT insourcing to an organization. It seeks to explain and educate each topic to various stakeholders within the organization.

In order to properly assess each topic, 10 pieces of literature were evaluated for their most prominent points on the topics, if a topic reoccurred within another piece of literature it was documented in summary tables with the most reoccurring topics to be discussed. For example, there are summarised pie charts which highlight the primary topics.

The key findings include:

Reduced Costs as the primary reward for insourcing and outsourcing Contract/Trust Issues as the primary risk of outsourcing Complacency and resistance to cost reduction are prominent in insourcing Selective Sourcing as a better alternative to insourcing or outsourcing Lack of research and understanding of insourcing The various perspectives of stakeholders impact the view of the risks and rewards of

IS/IT insourcing and outsourcing.

The most prominent risks and rewards of IS/IT insourcing and outsourcing can be briefly summarised using the below framework:

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Contract Issues

Trust IssuesReduce Costs

Complacency

Resist Cost Reduction Strategy

Lower Costs

Improve Service Levels

IT

Out

sour

cing

Inso

urci

ng

Risks Rewards

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Table of Contents

Executive Summary...................................................................................................................1

Table of Contents.......................................................................................................................2

Risk and Rewards of IT Outsourcing.........................................................................................3

Risks and Rewards of IT Insourcing..........................................................................................5

Limitations of research...............................................................................................................7

Conclusion..................................................................................................................................8

References................................................................................................................................10

Methodology............................................................................................................................11

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Risk and Rewards of IT Outsourcing

Risks:

Contract Issues:

Ill-defined contracts with vendors particularly mega-deals can be more expensive than IT

(Lacity et al, 1996). Barthelemy (2001) argues that excluding the vendor, the contract is

probably the most important part of outsourcing. As a poorly defined contract may leave

open questions which could contribute to disaster (Barthelemy, 2001) which may lead to IT

managers to terminate the contract and rebuild the internal IT organization (Hirschheim &

Lacity, 2000).

Due to the complex nature of contracts, they often rely on mutual interest and commitment

(Lee et al, 2003). Earl (1996) discusses how organizations should avoid contracts which are

set in stone such as long term contracts which may hinder the growth of the organization.

Short-term contracts have proven to be more successful (Lacity & Wilcocks, 1998). They are

able to motivate vendor performance, allow quicker recovery from mistakes and helped to

ensure a fair market price.

Trust Issues:

According to Lee et al (2003) mutual trust is key to a long term successful partnership in

outsourcing. For example, an organization could specify a looser contract which allow for

more feedback and agile improvement. (Barthelemy, 2001).

Nevertheless, it would be naïve to presume that the relationship would remain constant and

that the vendor would willingly adapt under the spirit of trust even if it was not specified in

the contract (Lacity & Wilcocks, 1998). These “CEO handshake” deals often managed to

save money in the short term but the relationship would continue to deteriorate as the effects

of a poorly negotiated deal came to life.

Rewards:

Reduced Costs:

Outsourcing is believed to lead to reduction of costs for a business organization (Lee et al,

2003). Researched conducted by Lacity & Willcocks (1998) indicated that cost reduction is

the prime reason for outsourcing with 80% of their participants citing it as a major influencer.

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Bartholemy (2001) discusses how IT is one of the most expensive aspects of an organization

to establish and maintain. However, large vendors with many clients will be able to operate at

a scale which most organizations cannot compete with. This will generally lead to better

negotiated deals with software and hardware suppliers.

For example, when British Petroleum and Mobil outsourced their activities to PWC, they

saved over 46% in cost savings in the first year (Quinn, 1999).

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Risks and Rewards of IT Insourcing

Risks:

Complacency:

Lacity et al (1996) warns a key risk of insourcing is creating an environment of complacency

in the organization. This is primarily due to ignoring the external market altogether thus

cutting off more cutting edge technology. Furthermore, the complacency created may reduce

IT managers desire to cut costs as there is a legacy of complacency (Lacity & Willcocks,

1998)

Resist cost reduction strategy:

In many cases, users may reject or resist cost reduction strategies implemented by senior management (Lacity et al, 1996). In comparison to outsourcing, IT does not have the influence to implement unpopular tactics such as software standardisation, this in turn leads to uninhibited users to drive up the cost. In fact, insourcing has led to lower costs but only after internal I.T managers were authorized to act as outsourcing vendors by senior management (Hirschleim & Lacity, 2000).

Lacity & Willcocks (1998) have previously discussed how internal users resist cost reduction strategy such as consolidating two data centres under the assumption that one data centre was superior to another.

Rewards:

Lower Costs:

IT managers in recent years have opted to propose internal bids as opposed to outsourcing

(Lacity & Willcocks, 1998). In many cases, senior management were often surprised by the

low cost bid. Furthermore, when cost reduction is the major objective, IT managers can often

replicate the success of vendors (Hirschheim & Lacity, 2000).

As previously discussed, IT managers must be enabled by senior management to behave like

an outsourcing vendor in order to produce results. For example, a US food manufacturer’s

internal departments once resisted internal IT budget cuts until threatened by outsourcing.

When the IT manager was enabled by senior management, IT costs promptly dropped by

45% (Lacity et al, 1998).

Additionally, research indicates that empowering IT managers’ bids may exceed their

proposal resulting in greater cost savings (Hirschheim & Lacity, 2000).

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Improved Service Levels:

Hirschheim & Lacity (2000) research indicates improved service levels when insourcing

occurs. Outsourcing vendors tend to focus on maximising profit by reducing staff, pushing

key staff members to entice new organizations and failing to introduce new technologies. As

such, users grew dissatisfied with the service and IT managers are able to successfully

leverage dissatisfied customers as justification to keep IT insourced.

Service excellence is a key requirement for end users and insourcing is a proven way to

improve service (Currie & Gallier, 1999; Hirschheim & Lacity, 2000).

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Limitations of researchIt is important to note there have been three areas of limitation in the research conduction: 1.)

Lack of research in insourcing; 2.) Ignoring selective sourcing; and 3.) Whose perspective is

the research for? Therefore I will briefly discuss each area and note their limitations.

1) Lack of research in insourcing

Despite insourcing being a proven method of cost saving, very little literature seeks to better

understand insourcing. Hirschheim and Lacity (2000) discuss how research neglects

insourcing and instead literature focuses on understanding the motivations and benefits of

outsourcing.

2) Ignoring Selective Sourcing

The research discussed in this paper reflects only on total insourcing and total outsourcing

instead of focusing on selective sourcing. Selecting sourcing allows organizations to select

the most capable and efficient vendors to handle some IT responsibilities which would allow

the organization to focus and develop their own core competencies (Lacity & Willcocks,

1998).

Currie & Galliers (1999) refer to selective sourcing as right sourcing due its treatment of IS

as a portfolio and it has proven to have higher success rates than either total insourcing or

outsourcing (Lacity & Willcocks, 1998).

Lastly, selective sourcing is able to meet customer needs and minimize the risks of traditional

outsourcing approaches (Lacity et al. 1996).

3) Whose perspective is the research for?

This assignment is based on the presumption that the evidence gathered is for an

organization. However, different stakeholders within the organization will have different

opinions on what the primary risks and rewards of insourcing and outsourcing are. For

example, senior management may focus on cost minimization as the primary objective while

end users focus on service excellence (Currie & Gallier, 1999). As a result, there is a

cost/service trade off:

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Conclusion In summary, there are numerous risks and rewards of both insourcing and outsourcing

approaches. The primary focus of both insourcing and outsourcing is to reduce costs for the

organization especially for senior management. However, users are more interested in service

excellence and as such IT often acts as a balancing act between cost/service:

Furthermore, the concerns discussed by various literature and the reoccurrences are illustrated below in these four pie-charts:

Rewards of Outsourcing

Reduce CostsFocus on Core CompetenciesHigher CapacityNew TechnologySkilled WorkforceAgile

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Risks of Outsourcing

Hidden CostsBusiness UncertaintyRebuild ITOutdated Technical SkillsContract IssuesLoss of SkillsTrust IssuesReliance on SuppliersDecreasing Service LevelsIncreasing IT Costs

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Rewards of Insourcing

Lower CostsEnable Business OperationsTrack and Access ITImprove Service Levels

As evidenced by the pie-charts, there is an apparent discrepancy between the research undertaken for both insourcing and outsourcing.

Lastly, the purpose of this research was to underpin the most prominent risks and rewards of insourcing and outsourcing, and use literature to expand upon these thought and provide a simplified summary. Therefore, the research aimed to explain each topic thoroughly for the intended audience.

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Risks of Insourcing

Complacency Resist Cost Reduction

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ReferencesBarthelemy, J., 2001. The hidden costs of IT outsourcing. MIT Sloan management review,

42(3), p.60.

Djavanshir, G.R., 2005. Surveying the risks and benefits of IT outsourcing.IT

professional, 7(6), pp.32-37.

Earl, M.J., 1996. The risks of outsourcing IT. MIT Sloan Management Review, 37(3), p.26.

Hirschheim, R. and Lacity, M., 2000. The myths and realities of information technology

insourcing. Communications of the ACM, 43(2), pp.99-107.

Lacity, M.C. and Willcocks, L.P., 1998. An empirical investigation of information

technology sourcing practices: Lessons from experience. MIS quarterly, pp.363-408.

Lacity, M.C., Willcocks, L.P. and Feeny, D.F., 1996. The value of selective IT sourcing. MIT

Sloan Management Review, 37(3), p.13

Lee, J.N., Huynh, M.Q., Kwok, R.C.W. and Pi, S.M., 2003. IT outsourcing evolution---: past,

present, and future. Communications of the ACM, 46(5), pp.84-89.

Kishore, R., Rao, H.R., Nam, K., Rajagopalan, S. and Chaudhury, A., 2003. A relationship

perspective on IT outsourcing. Communications of the ACM, 46(12), pp.86-92.

Wendy Autor Currie, Robert D. Galliers (1999) Rethinking Management Information

Systems: An Interdisciplinary Perspective, United States: Oxford University Press,

Incorporated.

Quinn, J.B., 1999. Strategic outsourcing: leveraging knowledge capabilities.MIT Sloan

Management Review, 40(4), p.9.

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MethodologyIn order to properly assess the risk and reward of both IT outsourcing and insourcing, I

created a table to represent the authors/ years and the primary risk and rewards as described

by the literature. I marked X when a key point matched an identified risk or reward in

literature before summing up the accumulated X’s.

I then chose the identified area with the most risks as the topics to be discussed. However if

one topic was identified 4 times and another was identified 4 or 3 times, I choose to discuss it

as it consistently reoccurred throughout the readings. If one topic was identified and the

closest was 6, I only discussed the 9 as it reoccurred far more throughout the literature.

Risk and Rewards of Outsourcing:

Risks and Rewards of Insourcing:

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