The Pros and Cons of IT Outsourcing

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.

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.

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.

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.