5 REASONS why Outsourcing should move up the CEO agenda
Why should hard-pressed CEOs devote attention to outsourcing? Because a substantial, and rapidly rising, amount of most large organisations’ cost base is already with outsourcing service providers. Because getting large-scale outsourcing wrong can seriously damage the business. Because, from now on, outsourcing is part of any future strategy. In our experience, the announcement of a large-scale outsourcing deal regularly has a positive effect on share price that can last between three and ten months. That said, the opposite can occur if the market perceives outsourcing to be an inadequate measure, given the scale of difficulties involved; where the deal seems to be flawed or hastily contrived; or where the CEO and organisations ultimately fail to deliver the financial results stated or implied in the initial announcement.
More positively, the evidence from our LSE Outsourcing Unit research shows clearly that outsourcing -- properly planned, resourced and managed -- can deliver significant competitive advantage to companies and organisations in all sectors. But only when the CEO plays a key role -- taking crucial strategic decisions, creating vital capabilities, putting in place integrated management processes and applying effective monitoring and evaluating mechanisms.
The Outsourcing Unit’s research points to five main reasons why outsourcing must now move up the CEO agenda. Let us look at these issues in more detail.
REASON #1: Outsourcing Impacts on Market Value
Share price is a fundamental barometer of corporate performance. Previous research, as well as our own case histories, have identified a significant correlation between firms outsourcing their IT infrastructure or back offices and a positive stock market response. Investors consider movement toward outsourcing as an important and generally favourable variable when assessing a firm’s worth. In the Outsourcing Unit’s experience, the announcement of a large-scale outsourcing deal regularly has a positive effect on share price that can last between three and ten months. Outsourcing is seen as a sign of active investment and management on the part of the firm.
That said, the opposite can occur if the market perceives outsourcing to be an inadequate measure given the scale of difficulties involved, where the deal seems to be flawed or hastily contrived, or where the CEO and organisations ultimately fail to deliver the financial results stated or implied in the initial announcement. The danger for the CEO is being swayed by short-term share price concerns and signing a large, long-term deal in order to try to shift the share price substantially upwards or perhaps to buy time rather than focusing on the fundamental business logic of the outsourcing deal. Long-term outsourcing contracts signed for short-term reasons invariably bring about major disappointments for CEOs and their organisations.
REASON #2: Outsourcing is Pervasive and Growing -- The Spending Alone Needs Attention
Outsourcing makes up a substantial and rapidly increasing proportion of expenditure in corporations and government agencies alike. Based on our figures, global IT outsourcing revenues exceeded $US 250 billion in 2008 and are scheduled to rise at 5-8% per annum over the next five years. Global business process outsourcing revenues were over $145 billion in 2008 and likely to rise by 8-12% per annum through 2009-2012. Organizations are choosing to outsource more and more and for a variety of reasons: to get to market faster, to cut internal costs, or to leverage he increasing capabilities of external services providers. For many organisations, outsourcing has become a major item of expenditure. However, this process is happening incrementally -- as a response to immediate market conditions and specific opportunities to cut costs -- rather than on the basis of long-term strategic thinking. CEOs, if they have not already done so, need to put such large spending on to a much more strategic footing.
REASON 3: Outsourcing Can Damage Corporate Health
The outsourcing highway is littered with casualties. We have seen even experienced organisations repeatedly running into massive problems, suffering from slow organisational learning, and working in a reactive rather than an anticipatory mode.2 Here are some 21st century examples:
- In 2000, UK retailer Sainsbury’s signed a 7-year $3.25 billion deal with Accenture to outsource its IT operations. By late 2004, the deal had been renegotiated twice, and Sainsbury’s had announced a 2004/5 write-off of $ 254 million of IT assets, and a further $218 million of automated depot and supply chain IT. The way forward was to reduce costs and simplify systems.
- In the face of poor financial results, the CEO of one of our cases signed a 10-year $520 million IT outsourcing deal with a single supplier. Within 17 months, he had been removed and the contract was then terminated prematurely. As well as paying supplier fees, the company incurred $50 million implementation and $30 million termination costs. More money was swallowed up in then rebuilding in-house capability and shifting to a multi-supplier model.
- A 2003 report into 182 outsourcing deals found more than a fi fth ended prematurely.
In 2004, JP Morgan and Chase scrapped its $5 billion contract with IBM two years into a 7-year
deal, concluding that much of the work could be better handled in-house. 5
- Also in 2004, Dupont was reported to have discovered $150 million in over-charges relating to outsourcing services with its supplier.
- In autumn 2004, the Child Support Agency-EDS deal surfaced as the latest in a long catalogue of outsourcing failures in the UK public sector.
While it appears that clients have a history of outsourcing experiences to draw upon, the problem is change. First generation clients often change what and how they outsource the second and third time around. Each time they find themselves in a relatively new situation, having to learn anew. Moreover, if their knowledgeable people have left and have not been replaced, organisational learning may not occur until the fourth or fifth generation deal.
Why should the CEO be involved? Because in outsourcing, strategic risk mitigation is fundamental. Furthermore, pursuing an operational, cost-reducing outsourcing strategy can drive costs down but often at the expense of other expected benefits. Strategic and even operational inflexibilities can result.8 As one example, while the Xerox-EDS 1994-2004 IT outsourcing deal successfully achieved cost reductions, at one point it damaged Xerox’s ability to respond effectively to a major change in market structure. In late 1999 Xerox lost control of its billing and sales commission systems, and this had major consequences for profitability. By the following year Xerox’s market share value had dropped from above $90 to below $20.9
The CEO must also care because, as the examples above show, strategic decisions to merge, acquire, or enter new markets can incur substantial unforeseen damage, delays and costs, if existing outsourcing arrangements need to be refocused.
REASON #4 : Outsourcing Can Play a Positive, Strategic Role
However we are increasingly seeing leading organisations utilise forms of outsourcing and partnering in order to:
- Penetrate new markets quickly
- Operate in new regions (for instance, Boeing sourcing IT to Malaysia to sell core products there or Dell looking to sell into China)
- Achieve strategic agility (for instance, adjusting volumes in response to business cycles or to provide business continuity in times of crisis)
- Achieve strategic sourcing (for instance, off shoring; using off shore competition to get better prices and service; best-of-breed sourcing)
- Enhance strategic capabilities by partnering with a complementary supplier.
In our latest research 10 we have also seen CEOs using outsourcing to pursue the following strategies:
- Financial restructuring: improving the business’s fi nancial position while reducing or at least containing costs
- Strengthening core competences: using outsourcing to re-direct business focus
- Technological or business processes: strategically strengthening resources, services and flexibility in these areas
- Organisational transformation: using outsourcing to facilitate or support major organisational change
- Business innovation: using outsourcing to introduce new processes, skills or technologies, while mediating the financial risks to drive for competitive advantages
- New markets: profit generation through joint ventures with vendor partners.
All of these demand close CEO attention. If these moves are fully to pay off, the CEO needs to shift from a tactical or arm’s length approach to outsourcing, to a much more strategic and personally involved one.
REASON 5: CEOs Alone Possess the Crucial Bargaining Power
There is one element in outsourcing which the CEO alone can bring to bear on the massive scale that is required -- bargaining power. Organisationally and strategically the CEO is the ultimate pivot of bargaining power. As a management process, the constant aim during the outsourcing lifecycle is to build and manage relative bargaining power. Enter that lifecycle without having first amassed the best possible bargaining power prior to negotiation, and you will find it almost impossible thereafter to improve your position. A key CEO role, therefore, is to ensure that their organisation’s bargaining power is sustained -- both through their personal infl uence with the supplier’s powerbrokers and by putting in place the strategies, processes and people needed to keep the relationship with the supplier sharply competitive and productively leveraged.
LSE’s Outsourcing Unit
(www.outsourcingunit.org). The Outsourcing Unit, at the London School of Economics (LSE), assists the Board and senior managers to extract enhanced value from its investments in IT and business process outsourcing. The Unit, which is independent, specializes in research and advisory work, and works with CEOs, CIOs and Boards to clarify the cost implications of different outsourcing approaches to manage complexity, facilitate innovation, evaluate and manage risk and ensure retention of core capability. In addition, the Unit provides individual mentoring, group workshops, facilitation for team building, and independent analysis of strengths and weaknesses of current approaches
Recent Outsourcing Unit Publications:
Oshri, I., Kotlarsky, J. and Willcocks, L. (2009) The Handbook of Global Outsourcing and Off shoring.
Lacity, M. Willcocks, L. and Zheng, Y. (eds.) (2010) China’s Emerging Outsourcing Capabilities.
Willcocks, L. and Craig. A. (2009) Step-Change: Collaborating To Innovate. Logica, London
Willcocks, L. and Lacity, M. (2009) The Practice of Outsourcing: From Information Systems to BPO
and Off shoring. Palgrave, London
1 Willcocks, L. and Lacity, M. (2009) The Practice of Outsourcing: From Information Systems to BPO
and Off shoring. Palgrave, London.
2 For evidence see Cullen, S. and Willcocks, L., Intelligent IT Outsourcing, Butterworth Heinemann,
Oxford, 2003; Kern, T. and Willcocks, L., The Relationship Advantage: Information Technology, Outsourcing and Management, Oxford University Press, Oxford, 2001; Kern, T., Willcocks, L. and Van Heck, E., "The Winner’s Curse in IT Outsourcing: How to Avoid Relational Trauma," California Management Review, 44, 2, 47-69; Lacity, M., and Willcocks, L., "Information Technology Sourcing Reflections," Wirtschaftsinformatik, Special Issue on Outsourcing, Vol. 45, 2, 2003, pp. 115-125.
3 Reported in Rohde, L. "Sainsbury, Accenture To Redo Outsourcing Pact", Computer Weekly
October 25th 2004.
4 Reported in Earle, A. ‘End of The Aff air: Bringing Outsourced Operations Back in-house’.
Computerworld, May 31st, 2004.
5 Wighton, D. "JP Morgan Scraps IT Deal With IBM", Financial Times, September 16th 2004.
6Reported by Miller, A, "Outsourcing Options and Performance Management In The Private and
Public Sectors". Presentation at the Outsourcing Summit, London, 22nd November 2004.
7 Collins, T. "MPs Given Little Comfort on State of Child Support Agency Systems", Computer Weekly,
28th October 2004.
8 Lacity, M. and Willcocks, L. (2009). Information Systems Outsourcing: Studies in Theory and
Practice (Palgrave, London). Also Lacity, M. and Willcocks, L. (2001) Global IT Outsourcing: In Search
Of Business Advantage. (Wiley, Chichester).
9 Kern, T. and Willcocks, L. (2001) The Relationship Advantage (OUP, Oxford).
10Willcocks, L. and Craig, A. (2009) Step-Change: Collaborate To Innovate, Logica, Londona