Cost can’t be the sole driver for IT outsourcing – shifting mind-set from activities to outcomes

Blog post   •   Mar 31, 2015 08:36 CEST

”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 centre in with the corporate outsourced data centre. However, regardless of how they twisted the business case the numbers just wouldn’t add up. The cost would double and there were no visible positive effects besides the intrinsic value of consolidation.

This CIO is in no way unique. I have met with several clients sharing the same experience; they can’t achieve any cost advantages in outsourcing the data centre and/or infrastructure operations. The effort required to maintain an internal data centre has been reduced, together with a shift to a more collaborative approach between development and operations. If anything, they all share the concerns of reducing time to market and achieving the planned benefits of outsourcing. The comparative advantage from economies of scale is nowadays being offset by automation, standardisation and new ways of working:

  • Increased automation
    • Provisioning of server capacity, internal or external, has never been easier and is just a few clicks away. New data centre architectures make complex tasks simple and automated.
  • Increased standardisation
    • The underlying technology is today fairly standardised and often comes with a range of powerful, easily operated management tools. The degree of proprietary expertise required to manage this standardised technology is decreasing.
  • 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 favours 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 nearly all their IT development work but maintains internal control over the data centre. Their rationale is that they need specialists to do complex development tasks, but delivering and operating their IT services in a run-state is too critical to outsource to a third party. They use IT sourcing as a means to obtain and create a competitive advantage, not solely to reduce cost.

An in-house data centre makes perfect sense, given that the amount of work required to manage infrastructure decreases. As technology becomes standardised, there is little or no discernible difference between an outsourced data centre and an in-house one. The case for classical infrastructure outsourcing is further undermined by 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 (e.g. sales, account management, project management, billing, marketing etc.) that needs to be offset by economies of scale and off-shoring. As the amount of manual work needed in the service delivery is reduced, economies of scale and off-shoring are turned into a disadvantage.
  • An outsourcing provider can form centres 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 centres of excellence are turned into sub-optimised delivery centres, focusing on a subset of the delivery instead of the end service provided to the customer.

A client in the retail industry said that they ‘sat out’ the first outsourcing wave and ‘got stuck’ with an internal data centre. Currently, their own data centre is unbeatable when they compare it with external providers. They continuously optimise their own delivery through application of modern tools, processes and technologies.

The financial institutions and the retail company share a common trait in that they seek to excel by sourcing capabilities that make them better with partners who can bring innovation. They want highly specialised and innovative service providers who can bring them state of the art application services – regardless of whether it is development or products.

There are of course other drivers of data centre and/or infrastructure operations outsourcing that are unrelated to cost. Nevertheless, as these cases illustrate it is no longer obvious that the cost can be reduced and cost reduction through outsourcing can create adverse effects through sub-optimisation. Using outsourcing to achieve cost reduction can become a major disappointment.

Gartner predicts that outcome-based services and solutions will transform the market. Time to market and flexibility are the main drivers shaping IT. This is also underlined in our own research into the state of IT service management in agile organisations and in our 3gamma annual insights survey, which confirms that time to market and flexibility to meet ever-changing requirements are key differentiators for IT organisations.

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 is 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, combined with continuous improvements, can achieve cost savings well above any outsourcing initiative. In the case of an outsourcing, it is imperative to avoid a transactional mind-set in the agreement and create reciprocal incentives for the entire sourcing life-cycle.

Authors: Jens Ekberg, Director, 3gamma

Jens EkbergJens Ekberg
Director Solutions and Offerings
+46 705 89 40 19