OUTSOURCING OF INFORMATION TECHNOLOGY ACTIVITIES
Outsourcing of Information Technology Activities
Information technology (IT) has pervaded business and organisations because of the many benefits it renders to easing business processes. Advancements in information and communication technologies have facilitated the development of innovative approaches of running business activities and processes in organisations with come on the routine and regular aspects of a business being automated. However, in many cases information technology is deployed as a tool of facilitating business processes rather than a core activity that generates direct revenues. As such, outsourcing of information technology activities and services has been used by many business enterprises, which do not consider IT as a core component of their business operations. According to a survey conducted by Delloitte (2014) in 2014, technological innovations such as business process as a service (BPAS), enhanced mobility, bit data and cloud computing were changing the information technology outsourcing environment with there being an increasing demand for service in real time and content of high quality.
Outsourcing is concept involving the involvement of third parties to perform business activities on behalf of an organisation, which does not consider the outsourced processes and activities to be core to its operations. Various models of outsourcing exist depending with the remoteness of the third party provider of outsourced activities. The main outsourcing models used include onshoring, nearshoring and offshoring (Dolgui & Proth 2013). Other information technology outsourcing models include staff augmentation, project-based outsourcing, managed services, out-tasking, and dedicated development centres (DDCs). The choice of the outsourcing model depends in the nature of IT services to be outsourced, the internal information technology capabilities of the company and the level of control the company wishes to maintain with its third party provider.
The ensuing discussion focuses on outsourcing of information technology activities and processes in organisations and compares the benefits and detriments that organisations would accrue from outsourcing their IT activities with those that do not outsource such as company ‘X’. The discussion begins with explaining the reasons as to why an organisation would choose to outsource its information technology activities and why another would not choose to undertake IT outsourcing. After that, a discussion on the disks of outsourcing information technology activities and the measures that could be undertaken to mitigate such risks is undertaken.
Background on outsourcing
Outsourcing is the transfer of organizational activities that were undertaken in-house previously to a third party provider (Lee, Ching Yeung & Hong 2012). Information technology (IT) outsourcing involves the contracting of various systems or certain information technology functions to outside independent information systems vendors, who may be individuals or companies (Ali & Green 2012).
Information technology outsourcing can be categorised by the location from where the outsourced work is undertaken and thus may include onshoring, nearshoring and offshoring (Dolgui & Proth 2013). In onshoring, also known as homeshoring, a company delegates its information technology functions to a third party who is located within the same national borders. In this case, a company could decide to outsource information technology services and functions such as payroll management, web designing, information system designing, data storage, data analytics and other related processed to third party companies or individuals located in the same country (Goldschmidt & Schmieder 2017). Indeed, crowdsourcing can be perceived as a form of onshoring in which organisations seek information technology capacity available in the public (Knop & Blohm 2016). Another outsourcing arrangement known as homeshoring involves the engagement of employees in the information technology department of a company working from their residences rather than from their workplaces.
Offshoring can be perceived as the other extreme end of outsourcing because, unlike onshoring, it involved the engagement of third parties who are located at great geographical distance from the company commissioning the outsourcing. In this case, the third party provider may be located in a different time zone, which in this case would be 5 or more hours away from the outsourcing company. For instance, a company in the United States may outsource its customer care services to a third party provider in Asia, which is located at the opposite end of the world and is at a different time zone. Moreover, nearshoring also known as nearshore outsourcing resembles offshoring because it involves the engagement of a third party who is located beyond the national border only that in this case, the service provider located in a country that is close to that of the outsourcing company (Oshri, Kotlarsky & Willcocks 2015). For instance, an organisation located in the United Kingdom or Germany could outsource web designing to France or Poland respectively, which are countries located in Western Europe and probably with little difference in time zone if not in the same time zone. Some companies may choose to engage in multisourcing in which they combine any of the three models of outsourcing models to outsource different function of their information technology. Indeed, the choice of the outsourcing model to be employed is dependent on and informed by the advantages to be derived by the outsourcing company.
Other models of information technology outsourcing are based on the relationship between the third party information technology provider and the outsourcing client. In this case, the client-vendor relationship can be categorised as staff augmentation, project-based outsourcing, managed services, out-tasking, and dedicated development centres (DDCs) (Raassens, Wuyts & Geyskens 2012). In the staff augmentation approach, a third party provider provides information technology specialists to the outsourcing client to design, develop and implement a new information system or to train the in-house information technology employees on certain specific issues related to their information technology functions. The workers that have been seconded by the third party provider remain under the management of their employer. Although such employees may be supervised by the outsourcing client, they are not engaged as full time employees by the outsourcing client. In addition, in project-based outsourcing, unlike in workforce augmentation in which the third party fills in skill gaps existing in the information technology department of the client, the third party provides expertise that is exclusive and lacking in the client’s organisation (Sparrow 2012). In this case, the information technology function that has been outsourced does not constitute the core function of the client company and therefore it does not interfere with the daily running of business therein. For instance, a restaurant in the United Kingdom may approach an application development company in Ukraine to develop a food ordering and delivery application. The app developer undertakes the task without interference from the client apart from the initial specifications provided at the start of the project. Alternatively, a company may locate an information technology development centre in a remote location or country away from its company premises. However, the third party is tasked with the recruitment and hiring of the staff to run the dedicated development centre on behalf of the client company. As such, these workforce works directly with the management of the client company while being on the payroll of the third party provider. The level of expertise in an organisation, the closeness of the information technology function to the core activities of the company and the amount of resources the client wishes to sink into the information technology function dictate the choice of outsourcing models to be employed (Oshri, Kotlarsky & Willcocks 2015).
Various studies has exhibited the growth trend of outsourcing of information technology functions and provided reasons for such trends. For instance, Chang and Gurbaxani (2012) observed that an increasing number of organizations that had outsourced some or all of their information technology functions from external third party service providers had characterized the last twenty years, which was in sharp contrast with internal delivery of the same services as was the case previously. This was an indication that there was an increasing realization that information technology could only deliver benefits to the organization when organizations undertook to restructure the production of information technology services. This view was echoed by Gorla and Somers (2014), who observed that in the traditional scene, the products of information systems (IS) has been internally by in-house information systems departments of organisations. However, with outsourcing of information systems becoming an alternate or complementary mechanism for delivery of information technology services, information technology had experienced growth of 14 % annually with the information technology services market being valued at 746 billion dollars (Gorla & Somers 2014). Indeed, Ravishankar, Pan and Myers (2013) have attributed the popularity of information technology offshoring to the low operational costs in developing countries and emerging economies. In addition, the authors observed that the lowering of the costs of telecommunications, the liberalization policies of governments, world scale logistics, low costs for air travel, and the presence of large pools of English-speaking engineering graduates that are located in diverse countries globally had contributed to the success of the offshoring phenomenon in information technology functions and services. Specifically, they noted that the number of Indian IT services vendor organizations has become established and grown impressively in the last twenty years or so, which was an indication of the growing trend of information technology outsourcing (Malik, Sinha & Blumenfeld 2012). However, there were indications that outsourcing trend could be reversed in future with some indications of onshoring previously offshored tasks in information technology becoming increasingly evident. According to Deloitte (2014) some companies has become dissatisfied by the performance of their outsourced activities coupled with poor experiences with third party providers and the elusiveness of the cost targets that outsourcing was aimed at achieving in the first place.
Reasons why an organization would outsource its information technology activities
With outsourcing of information technologies having taken root in many firms, there is evidence that it benefits firms in various ways, thus informing the prevalence of outsourcing in many organisations. However, according to McCarthy, Silvestre and Kietzmann (2013), the success of an outsourcing undertaking was dependent on the congruence between capability fit and information asymmetry, which should lead to four outsourcing contexts including opaque outsourcing, symbiotic outsourcing, discordant outsourcing and inconsistent outsourcing. In addition, the standardization of many business processes has facilitated outsourcing strategies (Schäfermeyer, Rosenkranz & Holten 2012). With this in mind, the reasons why organizations outsource their information technology activities can be broadly categorized as financial reasons, business reasons, technical reasons and industry environment reasons.
Outsourcing renders financial benefits to organizations in various ways, which company X would not gain. First, an organisation may choose to outsource some or all its information technology activities to reduce operating costs. It has been established the external information technology providers can undertake information technology services at a lower cost than that in an internal information technology department in an organisation. The rational of this thinking is underpinned in the transaction cost in theory in which Aubert and others (2012) observed that the transaction cost theory (TCT) had been and influencer ot outsourcing decisions in various because the choice of the governance structure depended on transaction costs and production costs. While transactional costs were related to the search for suppliers, negotiating contracts, monitoring and evaluating performance, which incurred costs that firms sought to minimise, production costs were intrinsic to the company’s operations. Nonetheless, it transaction costs are too high, internalisation of business activities was recommended rather than outsourcing. In this case, uncertainty, asset specificity and frequency are characteristics that could explain the magnitude of transaction costs. Therefore, transaction costs are unavoidable because information technology systems are often capital-intensive undertakings requiring financial investments in acquiring information technology infrastructure, employing skilled information technology professionals on a permanent basis, and regularly updating information technology systems. Second, outsourcing of information technology activities can facilitate the improvement of cost control in an organisation. Because of enhanced focus on information technology provided by third party providers, they are able to operate overheads that are much leaner compared to those of an organisation that does not specialise in providing information technology services. For instance, an information technology provider may be operating in a location from where it can access skilled labour pools, and information technology equipment and infrastructure at costs that are lower compared to the outsourcing organisation. Third, outsourcing can deliver cash infusions to an organisation that has information technology assets. In this case, an organisation may have information technology equipment and systems, which are holding much of the company’s capital but do not deliver equivalent value to the business. As such, the company could decide to unlock the finances held by such investments with the savings made from outsourcing the replaced services from the equipment being directed to core functions and activities at the firm. Fourth, outsourcing can help an organisation restructure its information technology budget. Outsourcing involves contracts whose expenditure remains stable and known in the long term as such contracts are usually in force for a long period. Therefore, the predictability of expenditure provided by the outsourcing model facilitates the making of accurate budgets
Many organisations outsource their information technology activities because it makes business sense. This may explain why outsourcing success is closely related to the quality of information technology governance. According to Ali and Green (2012) ineffective information technology governance may affect organizations negatively because of inaccuracy of the information quality, inefficiency of operating costs, runaway costs due to under specifications and budget overruns associated with information technology projects, the demise of information technology departments and loss of competitiveness by the organisation. Therefore, the strategy of using thirds parties for undertaking some of the information technology functions has been informed by the need to address these problems. In addition, Jain and Thietart (2013) introduced the idea of knowledge-based transaction costs (KTC), which were often ignored by organisations and which could be influenced the success of outsourcing because they were costs related to transfer of knowledge during the outsourcing of information technology processes and functions from a firm to a to a contractual partner. In this case, a company that outsources its information technology activities is able to focus on its core competencies while company X, which does not outsource wastes organisational resources on issues in which it may not have sufficient competencies in and thus lacks business focus. Core competencies are a source of competitive advantage as explained by the core competencies theory (Vaxevanou & Konstantopoulos 2015). Therefore, maintaining a focus on the competencies that the company has developed over time helps the company maximise on its resources in a strategic direction that ensures that the company enjoys exemplary performance and attains business and organisational success (Murphy et al. 2012). In addition, outsourcing may help a company manage its business risks by spreading them through sharing them with other third party service providers. Indeed, business activities that are non-core to a company may present risks because the company may have limited capabilities and competencies in handling such activities. This may take a toll on the resources of the company, which are usually in scarcity and need to be well manages to ensure that they deliver maximum returns with leas risks to the performance of the organisation.
Moreover, the outsourcing company may be able to render round the clock services to clients. This is common with outsourced services that are facilitated by information technology such as customer service in which companies in the United States and Europe engage third party providers located across the globe in different time zones such as India and the Philippines (Manning, Larsen & Bharati 2015). This way such companies are able to ensure that their customers of continuous service, which in turn increases customer loyalty while helping the company gain presence in the offshore location as well.
The technical benefits that are accrued from outsourcing of information technology activities include the improvement of technical services, maintaining the focus of internal staff dealing with information technology activities on core activities, access to technical talent, and access to new technologies.
First, outsourcing delivers improved technical services associated with information technology activities because it allows a third party provider to handle the information technology activities that it has competence in and has well developed expertise in as well. As such, by allowing a competent provider to handle information technology issues, a company is able to benefit from the improved delivery of the technical services of information technology by a competent provider. Second, outsourcing enables a company to redeploy its information technology staff into other activities that make up the core business of the company. This is particularly useful when a company has few information technology staff or staff that have limited or selected expertise in some information technology aspects needed by the company. As such, the company can retain staff in the information technology department that oversees the internal information technology environment while enabling the organisation to build its capacity in information technology without losing the benefits accrued from advanced information technology solutions. Third, outsourcing can facilitate the access to technical talent without necessarily having to hire skilled information technology staff directly. Since, third party providers have highly skilled information technology personnel; this talent is accessible to a company that engages the provider thus enabling a company to benefit from their expertise without necessarily being directly involved with their management or human resource issues. Fourth, outsourcing enables a company to access to new technologies through the engagement of a dedicated information technology provider. Usually, information technology providers have to keep abreast the latest developments in information technology developments in order to provide the latest and most advanced information technology services and solutions (Chae, Koh & Prybutok 2014). They invest their resources to acquire the latest information technology equipment, develop advanced information technology solutions and adhere to the best information technology practices.
The trends in the industry may exert pressure on a company to undertake outsourcing of its information technology services and activities. Indeed, industry and economic trends may be beyond the control of the organisation yet they influence outsourcing decisions. The publicity given to the economic trends and other factors in a given industry may make outsourcing appear attractive or the accepted practice at a given time thus encouraging a company to engage in outsourcing of its information technology activities.
In addition, information technology vendors may exert pressure on organisations to opt for outsourcing of their information technology services because of the benefits they would gain from by making such decisions. Indeed, third party service providers compete viciously among themselves and engage in aggressive marketing activities to convince companies to engage them.
Risks of outsourcing and mitigation measures
Information technology outsourcing presents some risks that company X should be aware of, which may justify its reasons for not engaging in the practice. According to Gorla and Somers (2014), the problems presented by information technology outsourcing include slow implementation of information technology functions by the information technology service provider, delayed delivery of client data, lack of commitment by the IT vendor and degradation if information technology services. These problems present various risks that could undermine the performance of company X.
Outsourcing of information technology activities presents various risk to the outsourcing organisation, risks that company X, which does not outsource, is able avoid. Firstly, considering that information technology functions are varied and extensive in an organisation, outsourcing some of such functions may be difficult because they may be at the core of the business operations of a company. For instance, if company X relies on innovations of its services and products, then outsourcing of information technology function may erode the company’s ability to innovate, which in turn could erode the competitive advantage of company X. Indeed, according to Aubert and others (2012) the inability to control all the interdependent components involved in information technology functions can be limited by outsourcing, in turn, limiting the innovative capacity of the firm, considering that outsourcing it is an interdependent activity. Secondly, an organisation that outsources its information technology activities risks losing control over its most valuable information and the staff that handle such information. As such, company X would have to contend with rigid and inflexible client-vendor contracts, which are often long-term contracts (Sursala 2012). Sometimes company X would have to cancel such contracts with its third party providers if such providers were to fail to meet the expectations expected from the outsourcing of the said information technology functions (Mani, Barua & Whinston 2012). This situation would be worsened in the case of the dedicated development centre as an outsourcing model because company X runs the risk of losing all its control in the facility if the third party vendor was to acquire the unit by buying it off from the outsourcing company. An additional but related risk would be the poaching of information technology technicians who have been trained by the outsourcing arrangement, thus eroding the technical capacity of the company even after making investments in information technology capacity building. Thirdly, outsourcing presents the risk of having an organization becoming locked-in by a third party provider through stringent long-term exclusivity contracts. Locking in denies the company an opportunity to be independent in the manner it structures its information technology functions or in choosing another third party provider who would best deliver the expected information technology functions. This is because the client-vendor contracts may not have an exit close that would allow company X to exit in the short term suppose it became unsatisfied by the performance of one information technology provider (Keramati, Samadi & Nazari-Shirkouhi 2013). Fourth, outsourcing may reduce the morale of the staff within an organisation who may be concerned of being declared redundant because of the engagement of an external information technology provider. In addition, the threat of having automation replace human involvement in some processes within an organisation through information technology outsourcing may make employees jittery about the security of their employment and thus take a toll on their level of motivation and even loyalty to the company. Fifth, outsourcing presents the risk of loss of organisational trust by the employees within the firm seeking to offshore its information technology functions. In this case, company X would have to contend with the risk of being seen to have breached the employer-employee relationship because the employees therein would be uncertain about their jobs in future and would remain wondering whether their jobs would be next on the line to being outsourced. Loss of such organisational trust has a negative effect on the output and performance of employees. Moreover, lost of trust and loyalty in the organisation would lead to turnover of employees, thus eroding the human resource of the company. Sixth, sometimes the benefits expected from outsourcing of the information technology functions may not be realised because of the increase in transactional costs emanating from engaging an external third party provider. In many cases, the accounting system to be employed to account for the transactional cost savings is often not accommodated in the outsourcing arrangement. Indeed, the estimates of the cost of outsourcing may be inaccurate, and the making of the make-or-buy decisions would be difficult if there is absence of sufficient and accurate information to inform such decisions. Other hidden costs that would negate the cost effectiveness of the outsourcing model is the travel expenses associated with the movement to offshore locations which may be far-flung from the country of the outsourcing company. In addition, the involvement of a third party provider who is located at a different time zone may present communication inconvenience due to the large time differences between the client and the third party provider, thus presenting other hidden costs of outsourcing. Worse still, the third party provider may be located in a country whose national culture is starkly different from that of the outsourcing company. In this case managerial incompatibility between the client and the provider, which may be worsened by a language barrier is a risk to which that company X should be alive, which in turn should discourage it from engaging in offshoring especially. In the same respect, resolution of conflicts or problems would be a lengthy and costly undertaking and turnaround times would end up being slower than expected, eroding the cost effectiveness of the outsourcing model even further.
Mitigation of risks
Reduction and mitigation of risks associated with outsourcing of information technology can be achieved through certain prudent actions that are undertaken either before or during the outsourcing process. In this case, company X should engage in an internal audit of its information technology functions to identify whether outsourcing would be a viable solution, lacking which the company should engage in upgrading its in-house information technology capabilities and capacities. From another perspective, before a company engages a third party information technology provider, an analysis of what is to be outsourced and a corresponding risk assessment should be undertaken by the company. That way, an informed decision that is guided by evidence would be made from such an analysis. In addition, the company should evaluate its internal information technology capabilities and undertake a cost benefit analysis of undertaking outsourcing of information technology activities (Lee, Ching & Hong 2012). In this case, the company should be careful to include all the hidden costs associated with outsourcing in both the short-term and the long-term to ensure that there are no surprise costs that would emerge later into the outsourcing engagement after the client-provider contract has been signed. Further, the company should evaluate the model of outsourcing that best suits its information technology activities and the location of the service providers as well. Sometimes, depending on the cultural competence of the company, the choice of how far or culturally different the third party provider is becomes a matter to be considered. For companies with little experience with far-flung information technology providers, onshoring would be the preferable option to offshoring.
Outsourcing of information technology functions has been facilitated by advancements in information and communication technologies, labour mobility and liberal business regulations that have occurred in the last two decades. With many companies in the United States and Europe instigating the trend of outsourcing of information technology to developing and emerging economies of South America and Asia, the number of outsourced information technology has increased in the last two decades. Indeed the various benefits that outsourcing would provide a company include lowering of operational costs, enabling a company to focus on its core activities by outsourcing non-core information technology functions, and by enabling companies to enter into new markets, which would further their expansion strategies. However, outsourcing has various disadvantages such as eroding the ability of a company to control all its functions including the insecurity associated with information and valuable data, stifling the innovation capacity of a firm, and the elevation of the costs of operation from hidden costs associated with incompatible cultures and time zones (Nassimbeni, Sartor & Dus 2012).
Company X would therefore need to consider the risks of engaging in outsourcing of its information technology functions emanating from difficulty in making decisions as to which information technology functions to outsource, the possibility of a high staff turnover and loss of operational autonomy. However, if the company were to consider engaging in outsourcing its information technology functions, it should be able to undertake a comprehensive internal audit of its capabilities vis-a-vis its short and long-term strategies. In addition, the company should unearth the possible hidden costs that would negate the cost effectiveness of outsourcing, and undertake due diligence on the third party provider to guarantee provision of quality service.
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