”Consolidating our IT operations into the corporate outsourcing agreement would double the running cost, so why would I?”, this quote is from a CIO in the financial sector. The parent company was planning to consolidate their IT across the group, bringing the ‘daughter’ company’s data center in with the corporate, outsourced data center. However, regardless of how they twisted the business case the numbers just wouldn’t add up. The cost would double and there were no clear positive effects, besides the intrinsic value of consolidation.
Incredibly, this CIO is in no way unique. I’ve met with several clients sharing the same experience; they can’t achieve any cost advantages in outsourcing the data center and/or infrastructure operations. The comparative advantage from economies of scale is nowadays being offset by automation, standardization and new ways of working. The effort required to maintain an internal data center has been reduced, together with a shift to a more collaborative approach between development and operations. If anything, they all share a frustration of time to market, complex processes and working with a reactive outsourcing vendor.
- Increased automation
- Provisioning of server capacity, internal or external, has never been easier. It is just a few clicks away. New data center architectures make complex tasks simple and automated
- Increased standardization
- The underlying technology is fairly standardized today and each technology often comes with a range of powerful, easily operated management tools. The expertise required to manage standardized technology
- New ways of working
- Collaborative ways of working across departmental boundaries to support aggressive time-to-market requirements (e.g. DevOps or agile methodologies within IT operations) are not as easily implemented in an outsourcing context, which favors in-house delivery
- Mature and efficient IT service management processes and governance structures are no longer unique capabilities offered by outsourcing vendors, these are capabilities that can be acquired or built in alternative ways
Another Swedish company within the financial sector has outsourced basically all their IT development work, but maintains internal control over the data center; their rationale is that they need specialists to do complex development tasks, but when it comes to delivering IT services, it is too critical to outsource to a third party. They use sourcing as a means to obtain and create a competitive advantage, not solely to reduce cost.
An in-house data center makes perfect sense, given that the amount of manual labor required to manage infrastructure decreases. As technology becomes standardized there is no or little discernable difference between an outsourced data center and an in-house one. The case for classical infrastructure outsourcing is further undermined with the rise of the cloud and software as a service.
From a cost/value perspective, there are two key differences that can be used to explain this development:
- An outsourcing provider carries overhead to deliver the data center services (e.g. sales, account management, project management, billing, marketing etc.) that are required be offset by economies of scale and off-shoring. As the amount of manual labor needed in the service delivery is reduced, economies of scale and off-shoring are turned into a disadvantage, standardized processes, staffed with resources with little or no knowledge of the customer’s business.
- An outsourcing provider can form centers of excellence for certain technologies/resources, providing expert services to their clients that can be used to increase the value in the services provided. However, as these technologies/resources become a commodity the centers of excellence are turned into sub-optimized delivery centers, focusing on a subset of the delivery instead of the end service provided to the customer
Two weeks ago I met with a client in the retail industry, who said that they ‘sat out’ the first outsourcing wave and ‘got stuck’ with an internal data center. Currently their own data center is unbeatable when they are comparing it with external providers. They are continuously optimizing their own delivery through application of modern tools, processes and technologies.
Both the financial institutions and the retail company share a common trait, they are looking to source capabilities, which make them better, they want partners that can bring innovation, they want to excel. Data center and infrastructure operations do not seem to do the trick. They want highly specialized, innovative service providers, bringing them state of the art application services, regardless of whether it’s development or products.
There are, of course, other drivers of the data center and/or infrastructure operations outsourcing, unrelated to the cost perspective. Nevertheless, as these cases illustrate, it is no longer obvious that the cost can be reduced and that cost reduction through outsourcing can create adverse effects through sub-optimization. Using outsourcing to achieve cost reduction can become a huge disappointment.
It is critical to have a clear view of the case for outsourcing and clearly articulate the goals of an outsourcing initiative. If cost is on top of that list, it’s important to pay meticulous attention to the business case and make sure that you have a clear view of your current cost baseline and what measures can be taken to reduce that cost prior to moving into an outsourcing arrangement. The old saying ‘you can’t outsource a problem’, still holds true today. It is likely that a well-executed cost reduction or transformation program, and continuous improvements, can achieve cost savings well above any outsourcing initiative. In the case of an outsourcing, it is imperative to avoid a transactional mindset in the agreement and create reciprocal incentives for the entire sourcing life-cycle.