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Outsourcing Risks

By Brian P. Watson  |  Posted 11-06-2007 Print

Outsourcing Risks

Cutting costs and adding flexibility are two primary reasons companies turn to outsourcers. Businesses hire fleets of domestic consultants to focus solely on a particular project, which, in many cases, delivers a higher return than forcing internal staffers to juggle that project along with other responsibilities. For offshore outsourcers, the return, conceivably, is greater: The most talented workers in foreign countries typically work for less than most in the U.S. The formula appears to be working and remains high on CIOs' radar. In the next five years, top IT executives expect U.S. companies to outsource more work to foreign countries than to domestic providers, our January Future of IT survey found. Many of these senior executives believe U.S. firms will at least double their spending on IT outsourcing by 2012.

Still, outsourcing carries risks. Outside vendors can hold up projects and companies can lose internal competence by farming out tasks, according to Eric K. Clemons, professor of operations, information management and management at the Wharton School of the University of Pennsylvania. What's more, companies jeopardize their control over proprietary skills and information, Clemons says.

There are operational risks, too. In the past, when companies gave application specifications to developers, for instance, they would ensure efficiency and reduce potential errors through constant negotiations and "back-channel communications," Clemons says.

"As software is developed remotely, by people with very different cultures and very different experiences, and with very limited opportunities for back-channel interactions, the quality of the spec deteriorates rapidly," he says. "As clients outsource more sophisticated software development, the operational risk--the risk that the software simply will not fully conform to the users' requirements--is very dramatically increased."

And globalization is altering the geographic strategies most companies and outsourcers have employed in the past. Years ago, businesses pushed work to Japan, Korea and other countries where they could pay lower rates for top talent. Then workers in those countries started commanding higher fees than U.S. workers.

So the next great frontier became India. But fees there have been growing steadily--to the point where many companies are exploring the world for other countries with low-cost talent pools. "Chasing lowcost labor to do the same things has extreme limitations," Maitra says. "You're not going to stay on in India forever, because if you went there to reduce costs at a lower level, those costs are going up."

In our March outsourcing survey, a majority of executives expressed a willingness to outsource strategic IT functions and applications. Still, that will only go so far, says Rich Brennen, who heads the information officer practice at the executive search firm Spencer Stuart. "It's sneaking up more than it's becoming an inherent strategy," he says. "Will it ever get there 100 percent? That depends." For example, Brennen doubts that a firm like Merrill Lynch would ever outsource its trading system or a company like FedEx would farm out its supply chain system.

But that's not to say there won't be some surprises in the tasks companies decide to outsource. Brennen harkens back to the "creep" of outsourcing, pointing to industries that have used outside firms to produce what many would consider those companies' competitive advantages. He cites retail businesses that have farmed out not only the production of their apparel but also the design, as well as product manufacturers that now have someone else create their key product lines.

Few thought any of that would ever happen. And if it's any indicator of corporate motivation for divvying up IT work, more crucial projects will be done by outsiders in the future.

Next Page: Implications for CIOs


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