The Pros and Cons of IT Outsourcing

Panacea or poison?
BY YVONNE LEDERER ANTONUCCI, FRANK C. LORDI AND JAMES J. TUCKER III

EXECUTIVE SUMMARY
  • CPAs IN PUBLIC PRACTICE AND INDUSTRYheavy users of information technology (IT) themselvesare increasingly involved in the design, control and operation of their clients and companies information systems (IS). Therefore, they must advise clients or companies on using outside vendors to manage and support IT.

  • IS AND IT OUTSOURCING vendors may be individual IT professionals, consulting firms, employee leasing companies, full-service providers and CPA firms.

  • IT OUTSOURCING provides businesses with the ability to focus on core competencies, access state-of-the-art technology and increase flexibility and cost savings.

  • CRITICS OF OUTSOURCING IT ARGUE that it creates too much loss of control, less flexibility, questionable savings and the risk of being held hostage to one vendor or subcontractor.

  • IT OUTSOURCING IS NOT A PANACEA for all IT problems; in some cases, it may create as many problems as it is intended to resolve. CPAs should weigh carefully the numerous risks and benefits when advising clients or considering outsourcing for their companies.
YVONNE LEDERER ANTONUCCI, PhD, is an assistant professor of management at Widener University, Chester, Pennsylvania.
FRANK C. LORDI, CPA, is an associate professor of accounting and chairman of the Accounting and Taxation Department of Widener University.
JAMES J. TUCKER III, CPA, PhD, is an associate professor of accounting at the university.


As companies rely more on information technology (IT) to conduct businessfor example, accessing large market research databases to find new customers and using the Internet as a storefrontIT development and maintenance costs have exploded. It is easy to understand, therefore why companies consider transferring IT assets, leases and staff to third-party vendors that promise savings without losing ground to the competition.

In one of the largest U.S. outsourcing ventures, DuPont hired Computer Science Corp. (CSC) and Andersen Consulting for $4 billion over a 10-year period to develop and manage its IT. Other landmark IT deals include Xeroxs $3 billion deal with EDS and the McDonnell Douglas $3 billion deal with ISSC. But this is not simply a big company trend. Smaller companies also are taking advantage of outsourcings benefits, often contracting out portions of their IT to industry-specific consultants or facilities management companies. For example, short- term contract specialists, such as Users Inc., cater to the credit union industry. Smaller companies also outsource IT maintenance functions, such as help desk and training departments.

CPAs in public practice and industry, heavy IT users, are increasingly involved in the design, control and operation of information systems for their clients and companies. Therefore, they have to stay on top of these outsourcing trends. However, it is crucial that they stop and reflect on several important questions before they recommend that their companies or clients hire third-party vendors: What problems will outsourcing solve? Will a vendor really save them money? What are the risks?

Whether you are an IT outsourcing expert or simply considering the option for your client or company, you will benefit from this look at the pros and cons of IT outsourcing.


WHAT IS OUTSOURCING REALLY?
Today, IT outsourcing generally is defined as contracting with outside vendors to do various IT functions such as data entry, data center operations, application maintenance and development, disaster recovery and network management and operations. Vendors may be individual IT professionals, consulting firms, employee leasing companies, full-service providers and CPA firms.

BENEFITS CHECK
What are the advantages and disadvantages of looking outside the company to manage and support IT? Outsourcing proponents cite several reasons for choosing outside vendors.

Access to state-of-the-art technology. The volatility of information technology can quickly make IT skills obsolete. Software is updated and replaced very rapidlyby the time an entity invests in and trains its full-time staff, the technology may no longer be state-of-the-art. Outsourcing specialists must be well trained and up-to-date to survive.

Cost savings and quality. Fierce competition has led many businesses to restructure and downsize staffs in an effort to save money. As in the case of General Electric, even thriving companies do whatever possible to reduce staff and costs. Vendors may save money because they

  • Have much tighter control of fringe benefits and run much leaner overhead structures.

  • Use low-cost labor pools more aggressively and, with the help of modern telecommunications, can move data centers to low-cost areas.

  • Apply world-class standards to the companys existing IT staff, all of whom have to requalify for appointment at the time of outsourcing.

  • Can employ more effective bulk purchasing and leasing arrangements for all hardware and software.

  • Have better control over software licenses because they often are more informed negotiators.

  • Must meet deadlines because of contractual pressures.

Flexibility. Companies must be flexible enough to adapt to a business environment in constant flux, so their IT functions have to respond quickly to changing demands. Vendors often can tap a wide range of resources, skills and capacities while internal IT staff may have limited capabilities.

Job security for regular employees. Companies often hire outsourced staff with the understanding theyll be employed for a limited time. Thus, they can more easily drop or add people to the workforce without jeopardizing the companys reputation as a stable employer. More important, the use of outsourced workers buffers regular employees from fluctuations in demand and enables the company to establish a stronger relationship with its regular workforce than would otherwise be possible.

BALANCING REWARD WITH RISK
As users become more aware of the possibilities and limitations of information technology, they tend to become more critical of the internal IT function. A recent study revealed that a majority of senior managers viewed their companies IT functions as cost burdens rather than as strategic resources. They also perceived internal IT departments as being outdated, inflexible, expensive, unmanageable and lacking a customer orientation.

It is not surprising then that IT outsourcing has experienced such growth. Nevertheless, there is no conclusive proof that outsourcing always will lead to more focused organizations, higher flexibility, lower costs and staffing levels and economies of scale or to the solution of all problems with internal IT departments. In fact, outsourcing is not for every company or client.

With all the media attention focused on the projected benefits of major IT outsourcing deals, several questions emerge: Is IT outsourcing really as effective as proponents say it is? What are the risks, disadvantages and hidden costs? Here are some answers.

Media hype and outsourcing benefits. In Beyond the Information Systems Outsourcing Bandwagon , the authors concluded that managers often reported glowing success stories during the honeymoon period when the outsourcing contract was first signed. At that point, the client and vendor possess high outsourcing expectations. Projected savings often make the headlines while exorbitant fees for amendments to contracts are not made public because few companies wish to advertise mistakes.

IT is not easily outsourced. Because IT permeates an entire organization, it is not like other resources a company successfully outsourced in the past. IT outsourcing cannot be compared with outsourcing of security, logistics, legal services, advertising or the procurement of raw materials and components.

What Companies Say

The dimensions and the related perceived benefits of outsourcing have grown dramatically. A survey of over 1,200 companies by the Outsourcing Institutea professional association that provides information and products on outsourcing—reveals why managers like both long-term and short-term outsourcing contracts. The top-five short-term pros include

  1. Lower operating costs. Access to the outside providers lower cost structure is one of the most compelling short-term benefits of outsourcing. In a recent Outsourcing Institute survey, companies reported that on average they saw a 9% reduction in costs through outsourcing.
  2. More capital funds. Outsourcing reduces the need to invest capital in noncore business functions, thereby making capital funds more available for core areas. Outsourcing also can improve corporate financial measurements by eliminating the need to show return on equity from capital investments in noncore areas.
  3. A cash infusion. Outsourcing can involve the transfer of assets from the client to the provider. Equipment, facilities, vehicles and licenses used in current operations all have a value and are, in effect, sold to the provider as of the transaction, resulting in a cash payment to the client.
  4. Access to new resources. Companies may outsource because they do not have access to the required resources within. For example, if an organization would like to expand its operations, especially into a new geographic area, outsourcing is a viable and important alternative to building the needed capability from the ground up.
  5. Better overall IT management. Outsourcing is certainly one option for managing an out-of-control IT function. Outsourcing does not, however, mean abdication of management responsibility, nor does it work well as a kneejerk reaction by companies in trouble.

The top-five long-term benefits are

  1. Improved business focus. Outsourcing lets the company target broader business issues while leaving operational details to an outside expert. For many companies, the single most compelling reason for outsourcing is to relieve management of the how issues that siphon off huge amounts of managements resources and attention.
  2. Access to world-class capabilities. By the very nature of their specialization, outsourcing providers bring extensive worldwide, world-class resources to meeting the needs of their customers.
  3. Accelerated reengineering benefits. Outsourcing is often a byproduct of another powerful management toolbusiness process reengineering. It allows an organization to realize immediately the anticipated benefits of reengineering by having an outside organizationone that is already reengineered to world-class standardstake over the process.
  4. Shared risks. There are tremendous risks associated with the investments an organization makes. When companies outsource, they become more flexible, more dynamic and better able to adapt to changing opportunities.
  5. Free resources for other purposes. Every organization has limits on the resources available to it. Outsourcing permits an organization to redirect its resources from noncore activities to activities that have a greater return in serving the customer.

Information technology evolves rapidly. Because IT evolves so fast, predicting beyond three years is highly speculative. Hence, signing long-term IT outsourcing contracts is risky.

Mercurial economics. Although priceperformance improvements occur in every industry, in few do the underlying economics shift as fast as they do in IT. For example, a mainframe that cost $1 million in 1965 costs less than $30,000 today and probably will cost 20% to 30% less next year. This makes it difficult for decision makers to evaluate costs of outsourcing bids.

The cost of switching is high. A shakeout has taken place among IT vendors, with mergers and takeovers becoming commonplace. It is likely that fewer suppliers will survive in the future, making it more difficult to shop for the right price.

Loss of control. Critics of IT outsourcing argue that no outside vendor can match the responsiveness and service levels offered by an in-house function, largely because the outsider is not subject to the same management direction and control as employees. In addition, concerns exist with outside vendors about confidentiality of data, strategic applications and provisions for disaster recovery.

Bad for employee morale. Outsourcing often results in layoffs or the transfer of existing employees to the IT vendor. Such displacement can set morale into a tailspin and cause even talented staff to fear for their employment security.

Less flexibility. The outsourcing vendor provides the level of IT services specified in the contract using the technological platform it deems appropriate. Unless specifically spelled out in the contract, a company may lose the flexibility of moving to new computing platforms.

Due-Diligence Checklist

Useful questions to help CPAs determine if a vendor has the right resources and experience their companies or clients need.

  • What is the vendors reputation? Are there any conflicts or problems? Will the vendors culture fit with the companys or clients?

  • What is the vendors history? How long has it been in business? Have there been any unusual peaks or valleys? Has the vendor been in any significant/relevant disputes or litigations?

  • Is the vendor financially secure? What is the vendors market share? Are there any pending or threatened claims that could affect the vendors financial standing? Has the vendor acquired or divested entities recently? Ask for a copy of the most recent financial statement or annual report.

  • How is the vendor organized? By industry? By value of contract? Is there one international outsourcing entity or is there a web of local entities that work together?

  • How does the vendor handle resource distribution? Where are the vendors data centers? Where are the vendors employees located? Does the vendor have resources in the companys or clients city? What is the extent of these resources?

  • Does the vendor have experience with your current or future technology environment? Does the vendor have the capabilities to provide other services, such as reengineering? Ask for examples and references.

  • Does the vendor have experience dealing with organizations in your clients or companys industry? Ask for examples and references.

  • What is the vendors experience transitioning employees? How many transitions has the vendor done? In what states/countries? Has the vendor ever been sued in connection with a transition?

  • What is the vendors experience with implementing new systems?

  • Does the vendor typically partner with another entity to provide certain services? If so, who? What is the relationship with the partner?

  • Ask for references and contact names.

Adapted from Information Technology Outsourcing Transactions, Process, Strategies, and Contracts . John K. Halvey and Barbara Murphy Melby. John Wiley & Sons, New York City, 1996.

Being held hostage. IT professionals argue that outsourcing allows the user to become a hostage of the vendorthe company may lose technical staff and be locked into the vendors proprietary software and hardware. In a long-term contract, the customer has more leverage in negotiations, but the vendor has more leverage after outsourcing is under way.

Cost savings? Many managers assume that outsourcing vendors are inherently more efficient due to economies of scale. (The economies-of-scale theory says large companies can achieve lower average costs than small companies due to mass production and labor specialization efficiencies.) In the outsourcing arena, however, this model may not always apply. For example, small companies may have lower costs than large companies by employing older technology, offering below-market wages and maintaining tight controls and procedures.

Best Reading

Books

  • Beyond the Information Systems Outsourcing Bandwagon . Mary Lacity and Rudy Hirscheim. John Wiley & Sons, New York City, 1995.

  • Information Systems Outsourcing Decision Making: A Managerial Approach. L. A. de Looff. Idea Group Publishing, Hershey, Pennsylvania, 1997.

  • Information Technology Outsourcing Transactions, Process, Strategies and Contracts. John K. Halvey and Barbara Murphy Melby. John Wiley & Sons, New York City, 1996.

  • Leading Trends in Information Services. Deloitte & Touche LLP, New York City, 1996.

  • Outsourcing for ImpactPartnering for Excellence. Andersen Consulting, Chicago, 1996.

Articles

  • How to Manage an IT Outsourcing Alliance. F. McFarlan and R. Nolan, Sloan Management Review . Winter 1995.

  • Information Systems Outsourcing. H. Rao, K. Nam and A. Chaudhury, Communications of the ACM, July 1996.

When vendors submit bids that indicate savings, CPAs should always consider whether they can achieve similar results themselves. If the vendor is not inherently more efficient, perhaps the company can reduce its own IT expenses through data center consolidation and resource optimization.

Subcontractors. Companies that outsource often are unpleasantly surprised to find that their vendors arent working on their projectssomeone else is. Outsourcing vendors in search of hard-to-find technical skills often subcontract portions of their computer system work to small, unknown companiesall without the knowledge of their clients. These subcontracts can cause problems, including viruses brought in by subcontractors, poor communications, high costs and low-quality service.

CHOOSE WISELY
Outsourcing major IT functions will continue to grow at a rapid pace. The continued strong growth of both the depth and breadth of IT outsourcing suggests that this management practice is more than just a passing fad and that, under the right circumstances, IT outsourcing may provide the advantages noted by its proponents. For companies that have successfully outsourced various IT functions, the question is not Should we outsource? but, rather, How much should we outsource?

However, IT outsourcing is not a panacea for all IT problems; in some situations, it may create as many problems as it is intended to resolve. Given the important implications of IT outsourcing, CPAs should carefully weigh the risks and benefits of this management practice when advising clients and working with IT vendors.

Outsourcing Contacts (U.S. and International)

Andersen Consulting
33 West Monroe Street
Chicago, Illinois 60603
312-372-7100
www.ac.com

ALLTEL Enterprise
Network Services
4455 LBJ Freeway
Suite 1100
Dallas, Texas 75244
972-866-1400
www.alltel.com

AT&T
25800 Science Park Drive
Cleveland, Ohio 44122
216-292-2668
www.att.com

Cap Gemini
130 Shaftesbury Avenue
London W1V 8HH
England
171-434-2171
www.capgemini.co.uk

Coopers & Lybrand
Client Service Office
State Street Centre
80 State Street
Albany, New York 12207-2591
www.pwcglobal.com/us/

(CSC)
Computer Sciences Corp.

2100 East Grand Avenue
El Segundo, California 90245
310-640-0285
www.csc.com

Daimler-Benz InterServices
(debis) Systemhaus

Fasanenweg 9
D-70771 Leinfelden-
Echterdingen
Germany
49-711-972-2664
www.debis.de

Deloitte & Touche
Consulting Group

600 Renaissance Center
Suite 900
Detroit, Michigan 48243-1704
313-396-1704
www.us.deloitte.com

Digital
111 Powdermill Road
Maynard, Maine 01754
978-493-5111
www.digital.com

EDS
5400 Legacy Drive
Plano, Texas 75024
972-604-6000
www.eds.com

Ernst & Young
Business Transformation
Synergy Group
Denny Seese
515 South Flower Street
Los Angeles, California 90071
213-977-4355
www.ey.com/home.asp

Fiserv
255 Fiserv Drive
Brookfield, Wisconsin 53045
414-879-5000
www.fiserv.com

GSI International
Consulting Group

55 University Avenue
Suite 1601
Toronto, Ontario,
Canada MfJ 2H7
416-777-2525
www.gsigroup.com

IBM
Old Orchard Road
Armonk, New York 10504
800-426-3333
www.ibm.com

KPMG Peat Marwick
Outsourcing Solutions

Philip A. Garland
National Partner in Charge
2001 M Street, N.W.
Washington, D. C. 20036
202-739-8680
www.us.kpmg.com/consulting/solutions/outsourcing/

Outsourcing Institute
45 Rockefeller Plaza
New York, New York 10011
212-348-5507
www.outsourcing.com

MCI Systemhouse
200 Park Avenue
6th Floor
New York, New York 10166
800-234-4586
www.systemhouse.mci.com

Philips
Electronics

10960 Wilshire Boulevard
Los Angeles, California 90024
800-883-3767
www.softsearch.com

Price Waterhouse
Thomas O. Beyer
6500 Rock Spring Drive
Bethesda, Maryland 20817
301-897-5900
www.pwcglobal.com/us/

SIMS Software
P.O. Box 607
Solana Beach, California 92075
619-481-9292
www.simssoftware.com

Unisys
P.O. Box 500
Blue Bell, Pennsylvania 19424
800-874-8647
www.unisys.com

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