Outsourcing in IT projects: money saver or money waster?

Generally speaking, outsourcing is an arrangement whereby an external contractor enters into a contract with an organization for the provision of goods and services which previously have been provided in-house. Nowadays, in these tighter economic times, more and more companies are turning to outsourcing as a method to reduce and control IT costs. The primary argument in favor of outsourcing is that services can be purchased for less money than it would cost to develop them. Contractors may be able to provide services at a lower cost through the use of greater management and labor productivity, economies of scale, and the use of skills or technology unavailable before.

The benefits…

First, a huge economic advantage of outsourcing is that savings can result from the reduction of IS staff. Often the cost of outsourcing is less than employing specialist staff and sitting them down in a fully equipped office. Training, and retaining IS professionals is a serious challenge for many organizations. Frequently, having invested significantly in IS employees, organisations loose them, because they have been offered higher pay elsewhere. Moreover, it could be the case that some of the skilled IS staff may only be required occasionally. Outsourcing shifts this human resources problem from the organisation to the vendor, which can result in significant cost savings.

Second, most outsourcing contracts are fixed price contracts, which for many organisations eliminate the burden of escalating uncertain costs, frequently associated with information technology. Outsourcing often results in a significant reduction in overhead expenses and makes financial estimates of expenditure easier to determine, because contractors must meet legally binding contracts with specified costs. In addition, they may be subject to penalties clearly specified in the contract for failure to perform their contractual obligations. That is why outsourcing provides an unambiguous approach to arriving at a detailed cost structure of IT operations. The costs become predictable for the service receiver, since the responsibility of cost overruns is often placed on the service provider.

Third, outsourcing can provide cost savings by encouraging innovative solutions through access to a wider knowledge base, new ideas and new technology. Contractors may be able to offer specialist expertise and sophisticated technical solutions which a company agency may not be able to afford or maintain using its own resources. Outsourcing can give immediate access to the latest equipment and to otherwise unavailable state-of-the art technology, while saving them the costs of buying their own assets of this sort. In addition, outsourcing can help avoid the cost of up-front purchases of equipment, while the intangible costs savings resulting from standardization of machines could be significant. Furthermore, savings could also arise from not having to maintain the permanent capacity of hardware and software to complete infrequent tasks.

Many high-level managers are promoting the idea that just because their staff can do the job does not mean that they must be the ones to do the job. Organisations that consider outsourcing as an alternative to their own IS departments often find that the productivity of the IS staff increases and the quality of IS services and user orientation improves, which translates into cost savings. Even better, it makes the IS department acutely sensitive to the cost of providing different services.

Since companies are often distracted from their fundamental strategic thrusts in the marketplace by the ongoing impediments associated with an increasingly complex IS infrastructure, outsourcing allows organisations to refocus their business efforts towards higher level issues and to devote their time and resources to strategic issues, rather than on day-to-day operations, thus increasing the profit of the organisation in general and saving money.
Frequently, organisations find their IS experts spending more time maintaining existing products rather than creating new ones and introducing new technologies. To better use the time and talents of their IS experts, organisations often outsource noncritical, yet time consuming daily information processing tasks to outside vendors. By fully using the
expertise of their IS specialists and enabling them to focus on what they do best, an organisation can gain considerable economic advantages.

Not as bright as it seems…

However, outsourcing may not always be the cost saver it appears. The easiest way to blow an organisation’s budget on an outsourced project is to fail to define the details in the agreement. When companies do not specify clear requirements, delivery deadlines, and budget limitations, it usually results in vendor spending more time and charging more money than the client expects. Costly contractual amendments are related to the level of uncertainty of the outsourced activity. When requirements, quality criteria, service levels and so on are not well defined, the client is likely to ask for adjustments and contracts have to be reopened and modified. Such modifications often bring additional costs. Technological discontinuity is another source of contractual amendments. Since very few contracts make it mandatory for a supplier to respond to unforeseen technological changes, it is likely that the client will have to pay quite a high premium when these changes actually occur. What is more, an organisation may find itself in a lock-in situation, which often results from specific investments that were made by the supplier when the contract was first signed. At contract renewal time, if no other supplier is ready to make specific investments, the client does not have other alternatives but to continue the relationship with the current supplier. The supplier can then increase its fees, because of this lack of alternatives. Therefore, the contractor will overcharge for the activities performed in order to obtain a higher profit from the relationship, if the principal lacks experience and expertise with management of outsourcing contracts.

Furthermore, the cost of information-technology outsourcing involves more than vendor fees and companies are largely unaware of hidden costs which is sometimes said to be the biggest outsourcing problem. Hidden transition costs include setup costs, redeployment costs, relocation costs, and parallel-running costs, while hidden management costs refer to the human resources that have to be put into managing an outsourcing contract. Companies often underestimate these two types of costs, which can increase quite rapidly. Another type of hidden costs, are those costs that the client assumed were included in the contract, but which, in fact were not. Examples include maintenance on personal computers, sales tax on equipment purchases, rewiring for office moves, which can add up to a significant sum. Hidden transition and management costs are likely to appear due to lack of experience and expertise of the principal with the outsourced activity. If the principal does not have enough knowledge to clearly specify its needs, it is probable that unexpected costs will be incurred during transition. Both partners will discover the existence of grey areas in the definition of the activity, once again adding to the original cost.

Another type of hidden costs are contracting costs, that include the costs related to searching and evaluating the appropriate vendor, benchmarking the services offered, specifying the legal terms of contracts, negotiating contracts, and resolving disputes. The costs of negotiating and monitoring the outsourcing contract are potentially wide ranging, indirect, and substantial. When searching for a vendor, organisations often try to spend as little time as possible. However, spending more time at the search stage reduces hidden costs throughout the outsourcing effort and saves considerable expenses later. The process can take weeks or even months and, depending on what is being outsourced, may require site visits and travel costs. And in times like these, entrepreneurs need to spend even more time to dig into each vendor’s financial standing, in order to ensure that they will not go out of business the next day because as soon they outsource part of their business, they are dependent on that vendor.

From the point of IT executives, outsourcing reduces the perceived control over both the quality of software and the timetable of a project since the work is being carried out by people not under direct supervision. Any organisation that outsources will have to incur costs to supervise and monitor the agent. Performing weekly or even daily check-ins to make sure outsourced tasks are on track is important, because if an organisation does not manage to do it, it can result in messy code, missing deadlines, hire of additional staff, thus in wasting much more money. The claim is made that outsourcing is often associated with reductions in quality of service, because often the incentives for private contractors are clearly to provide the minimum service specified in the contract and nothing more, which of course translates into huge money losses.