Conclusion 04

By Gary Bolles

Outsourcing 2002: How CIOs Reach Outsourcing Deals




Many CIOs say they're eager to save money by outsourcing—no surprise in these tough economic times. However, our second annual survey on outsourcing finds there's no stampede going on. Cost is now the number-one reason for outsourcing, cited by the 396 top IT execs we polled, but the share of the IT budget going to outsourcing services is expected to decline slightly in 2002 compared with 2001. Outsourcing projects have been cut back, and "business process outsourcing"—supposedly the next hot outsourcing trend—still hasn't caught on. But despite the pressure they face to reduce costs, most CIOs aren't pushing to negotiate better terms when contracts come up for renewal.

One study also found that while cost is important, several rationales for outsourcing—lack of internal expertise, desire to focus on core competencies and lack of internal staff—are also of great importance.

A growing number of outsourcing contracts went to large computer companies and Big 5 accounting firms in 2001, though whether this will continue in a post-Enron world is anybody's guess.

CIOs are leaving money on the table, and not watching costs as closely as they could. Not only are few CIOs seeking better terms for contracts, but most aren't consistently tracking outsourcing's hidden costs, such as the cost of vendor searching and contracting, contract management and post-outsourcing reintegration.



It was not one of the better days of David Reid's professional life. He was then the CIO of a fast-food restaurant company that had outsourced its help-desk function before his arrival, and Reid was trying to manage the constant friction between the two firms. His company wanted excellent service, the outsourcer wanted to control costs.

And then on this particular day, it happened—one restaurant's point-of-sale system went down, and stayed down for 24 hours. The restaurant was in turmoil. Employees trained to enter orders on an electronic screen scrambled to write them down on slips of paper. Mistakes were made, and customers stalked out angry. "There are very few places where IT interfaces directly with the customer, and this is one," Reid recalls with a sigh.

Behind the scenes, the point-of-sale data was no longer feeding a database that the store manager used to track inventory, analyze customer traffic, estimate raw material orders and project staffing needs.

Phones rang "all the way to the top of the food chain," as Reid puts it, meaning the CEO of the small company—and the message came back down to him: "(Expletive deleted) put someone in a car and drive to the store and fix it if you have to." After this problem happened several times, Reid brought the help desk inside.

Today, Reid is CIO at The Krystal Co., in Chattanooga, Tenn., which has 415 fast-food restaurants around the Southeast. He's outsourced the installation of its POS systems because it makes sense for a geographically dispersed firm. But otherwise, he keeps support for his POS systems inside, unless an unusual problem arises that requires outside help to fix. For what does go out, he's older and wiser about service-level agreements and other controls.

Reid's story illustrates several key results in our survey. CIOs are focused on the customer and are more likely this year to do their own customer relationship management in-house. They distinguish between strategic and commodity functions when making outsourcing decisions. And they recognize the value of SLAs and other controls.

John Hill, CIO of Praxair, Inc., a Danbury, Conn.-based supplier of industrial gases, decided to keep CRM inside. "CRM is a critical corporate asset, and the impact of not doing that well has such a big liability," Hill says. "You're better off having that done by people who are really part of the company." At the peak of the hype about CRM, CIOs were challenged by management to implement it quickly, and outsourcing was the only way to do that. "But CRM has become demystified, dehyped," he says, "and companies are becoming a little more rational."

Hill did decide, however, that he could get a higher level of quality and service by turning some of his South American data center operations over to outsourcers. "Our strategy is selective outsourcing," he says. "We look at the project, what we're good at, and where we can take advantage of improved skills, as well as scale and efficiencies, from the outsource provider. Very rarely do we do outsourcing deals just to save money. At the end of the day, the fundamental measure is the quality of service and the speed of delivery."

Stephen Lane, research director of IT services at the Aberdeen Group Inc. in Boston, points out that CRM is an opportunity to increase revenue, and therefore becomes strategic. "Those types of applications are business-critical, and they're not going to get outsourced in any economic environment," he says. "Things that are commodities—human resources, accounting, payroll—aren't core to the business."

The largest jump in the use of application outsourcing among our respondents, in fact, was for human resources information systems. "Employees are demanding self-service, and nobody knows how to do it in-house," says Beth Ellyn Rosenthal, editor of the Outsourcing Journal. "Everybody wants to go to an intranet and look up their 401k and how many vacation days they have left. HR doesn't want to do it. Everybody wants it yesterday, and outsourcing is a lot faster than doing it yourself."

Also down is the outsourcing of Web site development and Web hosting. Lane and others see this as a return to more normal levels after a spike of outsourced Web activity during the dot-com boom. "Just about everybody has a Web site now," Lane says, "so the need to go out and have someone develop one and host it has fallen off."

Cost cutting, the traditional raison d'être of outsourcing, was at the top of our participants' list of motivations. They say, however, that finding the right skills is also a big part of the decision. What they are looking for is the flexibility to pick the best, and cheapest, solution. The calculation includes both outsourcing and contract workers.

"I start out with flexibility and drive to cost," says Jerry Hale, CIO of the Eastman Chemical Co. in Kingsport, Tenn. "If I have a large portfolio of projects with a high rate of return, I want to be able to turn up the staffing level. But if my workload should go down or the economy be down as it is now, I want to be able to cut back and still have stable employment in my company."

Our survey data suggests CIOs have become more cautious in making decisions about outsourcing. For one thing, CIOs are giving more business to the big computer companies and Big 5 accounting firms. "You had an awful lot of outsourcing delivery models emerge during the dot-com bubble," Lane says, and a number of the outsourcers born then have gone away. "I think people have just retrenched and are saying, 'If I'm going to outsource, it's going to be with someone I know will be around for the next few years,'" he says.

And the use of service-level agreements is up sharply. "There's always an element of risk when you outsource," says Carrie Lewis, an analyst in technology management strategies with The Yankee Group in Boston. "Even with the best service-level metrics, you can run into problems. The vendor may not understand what the end-user is asking them to do; the end-user may not understand what the outsourcer can do. We don't hear about some of the disaster stories, but they can literally bring a company to its knees."

Rosenthal puts it this way: "If you enter into an outsourcing agreement without an SLA, shame on you. You don't get what you expect, you get what you inspect."

In the end, our survey detected a rather half-hearted satisfaction with outsourcing, and Reid offered an explanation. "Human nature being what it is, the people you're outsourcing to are trying hard but don't understand your business as you do," he says. "They have their agendas, and you have yours. I've learned to deal with the inefficiencies, such as project managers leaving and the like. It's the nature of the business. The general consensus is that it's not going to get any better. That's why most people continue to outsource but are lukewarm about it."—Terry A. Kirkpatrick

Research analysis by Gary A. Bolles

Research Results

Research Results

The results are available in Adobe Acrobat PDF format. To download the free Adobe Acrobat Reader plug-in, click here.

  • Outsourcing

Conclusion 01

Conclusion 01: Budgets & Contracts

Some might think that tough times would lead to a shift toward outsourcing. But with outsourcing budgets slightly lower and contracts on hold or scaled back, it's clear CIOs don't consider it a cost-cutting panacea; outsourcing contracts seem as vulnerable to cuts as other expenses. And the increased use of service-level agreements indicates firms are better at managing outsourcers.

IT outsourcing budgets have remained stable, dropping very slightly from a mean of 24% of IT budgets in 2001 to a projected 23% for 2002.

In the past six months, 59% of IT execs have delayed, canceled or scaled back outsourcing projects. Eighty percent say those projects are still on hold or resumed at a reduced activity level. Still, 84% say they're starting new outsourcing projects.

When outsourcing contracts expire in 2002, a mean of 38% of those contracts will be renewed, while just 25% will be renegotiated for a better deal, seemingly leaving money on the table at a time when the recession should give buyers greater leverage with sellers.

The use of service-level agreements rose from 66% in 2001 to 81% in 2002, with 86% saying they intend to use SLAs in the future. Uptime level guarantees also rose, from 49% to 65%.

Outsourcing's hidden costs still go unmeasured. Only 27% consistently watch the financial impact of activities like vendor searches, contracting management and post-outsourcing reintegration. Forty percent do so inconsistently, and 32% say they don't do it at all.

Conclusion 02

Conclusion 02: IT Functions

The market for outsourcing IT functions has been unpredictable during the recession. But the projected trend for 2002 is to cut back on outsourcing the functions that have been outsourced most frequently—most notably the development and hosting of applications and Web sites, due perhaps to the availability of dot-com veterans and laid-off IT staff.

Application development outsourcing was used by 62% last year and only 54% this year, still enough for first place. As for application hosting, 2001 saw more activity than anticipated—it was projected by 29% of respondents last year but done by 39%—but only 34% of companies expect to outsource this function in the next 12 months.

Demand for web site development outsourcing services is projected to drop from 42% last year to 30% this year, while demand for Web hosting should decline from 44% to 33%.

It's not clear the extent to which CIOs' interest in application integration outsourcing is translating into actual outsourcing activity. Forty-four percent expected to use this kind of service in 2001, but only 27% actually did. In 2002, 34% say they will—the largest projected increase of any IT function. Enterprise application integration services are expected to rise to 27% in the next 12 months.

Web site hosting was employed far more by smaller than larger companies, 58% to 38%, respectively, but help desk and end-user support services were used more by larger than smaller companies, 33% to 17%, respectively, probably due to the numbers of customers and users large companies need to support, which made outsourcing an especially economical approach.

Conclusion 03

Conclusion 03: Applications & Processes

Despite the hype, application and business process outsourcing has remained steady for the past few years, and is projected to remain so. Most application areas have seen 2 percent to 5 percent increases in outsourcing, hardly the groundswell expected in tough times. Business process outsourcing is still a fledgling trend: Processes with real bottom-line impact like customer service, logistics and purchasing are rarely being outsourced.

The largest jump in the use of application outsourcing from 2000 to 2001 was in human resources information systems (HRIS). Projected to rise from 14% in 2000 to 20% in 2001, outsourced HRIS usage actually grew to 30% from March 2001 to Feb. 2002, the 12-month period covered.

Tomer relationship management, which has received much outsourcing hype, was projected to be used by 30% of companies, but was actually employed by only 20%.

Projected differences between 2001 and 2002 are small, with the largest change found in business process/business re-engineering, used 30% last year but projected at only 21% in 2002.

Business ocess outsourcing isn't the growth area many are claiming; companies are planning to outsource processes at or slightly above the same low rates as last year. Customer service support was only outsourced by 12% of respondents in 2001, and other areas were even lower: 9% for logistics management, 8% for transaction processing and 6% for purchasing.

Probably due their complexity, larger companies were more inclined than their smaller counterparts to be-lieve they'd need to outsource business process and business re-engineering applications, 24% to 13%, respectively, and content management, 21% to 9%, respectively. Smaller companies more typically outsource payroll, 55% to 37%.

Conclusion 04

Conclusion 04: Drivers

While the recession has loosened the tight IT labor market, IT execs still feel compelled to outsource because they lack staff or skills. That makes outsourcing a necessity, not a choice—hence IT execs probably feel they lack the leverage to bargain for better deals when they renew outsourcing contracts.

When asked for their top reason for outsourcing, 25% gave cost savings as their leading reason, up from 4% in 2001. But when asked for their top three reasons, a lack of internal expertise (49%), focusing on core competencies (49%) and lack of internal staff (43%) rated higher.

Larger companies are more likely to outsource to develop applications and capabilities quickly, 26% to 17%. Smaller companies, however, more often outsource so they can focus on core competencies, 54% to 47%, respectively—one of the most frequently discussed rationales for outsourcing.

Twenty-two percent of CIOs said they wouldn't use the same outsourcing company again. Reasons included a strong preference to build internal staff (62%), the function being too core or sensitive to outsource (42%) and not enough value for the money (40%).

Conclusion 05

Conclusion 05: Satisfaction

Satisfaction with outsourcing is good but not great, clearly leaving room for improvement. IT execs were most satisfied with the work of vertical market outsourcing specialists, but these are also the group with the smallest increase in usage in the past year.

All firms earned satisfaction ratings in the same modest range, from a mean of 6 for Big 5 firms to 7.5 for "other," within a 1-to-10 scale. Oddly, vertical market outsourcers received the highest satisfaction rating (6.9), but the smallest increase in usage (1%), while seeing spending drop from 22% to 13%, perhaps signaling that generalist firms are getting better at vertical services and picking up business.

As might be expected in a challenging economic period, more CIOs reported in 2002 than 2001 that they had outsourced to a company that went out of business, from 30% to 42%.



Outsourcing remains an important tool for CIOs, consuming a full quarter of IT budgets, but they could be smarter about negotiating contracts. For example, it seems counterintuitive that CIOs aren't using the tough economic climate to cut better outsourcing deals. Though some may be locked in by long-term agreements, CIOs would do well to review current contracts to make sure they're getting the best terms possible. CIOs can also make headway on costs by consistently watching the hidden costs of outsourcing, such as vendor searches and contract management. IT executives with opportunities for handing off IT or business functions can also consider some targeted pilots to see if outsourcing can help them scale up, and down, their IT capabilities during an economic downturn—something few seem to be considering now.



How the survey was done: CIO Insight designed the Outsourcing survey together with Advantage Business Research Inc., a Lake Success, N.Y.-based supplier of custom research services. CIOs, chief technology officers, and vice presidents of information technology and services gathered from a number of sources, including third-party lists and other Ziff Davis Media publications, were invited to participate in the study by e-mail. The questions were posted on a password-protected Web site, and 396 qualified respondents replied from Feb. 27 to March 4.

This article was originally published on 05-15-2002