In the years of the unbridled IT boom, outsourcing was at the top of every IT manager’s agenda. Handing over IT tasks to external service providers offered many advantages, such as lower costs or higher system availability. Every company approached the subject from a different angle. There were organizations such as Deutsche Leasing AG, for example, that outsourced the whole area of IT to a service provider – in this case CSC Ploenzke. However, most companies restricted themselves to outsourcing individual IT tasks, such as the operation of the merchandise management systems, to an external company. As a rule, outsourcing customers only had business relationships with one service provider.
In addition, there was much discussion on the issue of which parts of IT should in fact be outsourced. While some looked for the answer in the sphere of “commodity technologies” – networks, desktops, and so on – the others believed that the maximum benefit lay in the outsourcing of business-critical applications such as SAP R/3. Both had good arguments to back up their views: the supporters of commodity outsourcing saw a danger in surrendering expertise in the key business processes, while those favoring the outsourcing of core applications expected a specialized service provider to deliver a greater degree of system stability at lower costs.
Strategic weak point
However, all the different approaches in the boom years had one thing in common: the outsourcing initiatives generally had no strategic concept to take account of future developments. Thus in recent years, we have seen a number of quite spectacular insourcing projects. A study conducted by the US management consulting firm Diamond Cluster concludes that 78 percent of companies with outsourced IT terminated their contracts earlier than scheduled. The reasons most often cited were unsatisfactory service, excessive costs, and a change in the company strategy.
The market researchers at Gartner Group also judge past outsourcing initiatives harshly: according to a recent study, 85 percent of all outsourcing contracts agreed since 2001 are renegotiated within the first three years. The reasons given were that existing contracts were not suited to supporting the long-term objectives of the company using the service.
Outsourcing service providers also suffer set-backs. As a result of market consolidation, a number of once promising providers went bankrupt, and others were bought up by large industry players. The recent sale of the ThyssenKrupp subsidiary Triaton to Hewlett-Packard shows that this competitive shakeout is not yet over. The IT subsidiaries of large companies, in particular, are potential items on the shopping lists of the renowned industry giants.
This development reflects a rethink on the part of users and service providers. “HP certainly didn’t buy Triaton because of its computer center capacities,” states Pascal Matzke, Director Consultant of market research firm Meta Group. “The reason was the technical expertise that Triaton can offer in a vertical market.” From the consultant’s point of view, vertical knowledge is becoming increasingly important for outsourcing providers: “The outsourcing market is divided in two. In the area of commodity services, price is the deciding factor. The situation is different for business-critical applications such as human resources. Here, the service provider’s horizontal or vertical specialization is at the forefront.”
The outsourcing of key business processes – called “transformational Services” at Meta Group – requires the service provider to have a detailed understanding of the industry or the user’s processes. As customers now have a better strategic approach towards the subject of outsourcing, service providers have had to react accordingly, as Matzke explains: “Companies are outsourcing processes to enable them to concentrate better on their core tasks, and also to allow them to react more flexibly to new company strategies and market developments.” Here, he sees a trend whereby individual processes and applications are run externally. For the providers, this means a higher investment in consulting, as the individual customer processes require a very large amount of customizing.
Good opportunities for growth
Despite the difficulties that were associated with outsourcing in the past, Matzke believes that the increasingly strategic approaches by customers offer good opportunities for outsourcing providers, and that the market will develop positively. However, the Meta Group expert regards the large providers, in particular, as the candidates for growth. Small service providers require a strong vertical specialization in order to have a secure future: “As a result of customers’ focused strategies, multi-provider approaches will increasingly be in demand. Spectacular ‘mega-deals’ such as those seen recently will be rare in the years to come.”
Matzke is not alone in seeing a rosy future for outsourcing. Other market researchers see this market as a driving force in the IT world. For example, in a recent survey of the 30 largest IT service providers, IDC found that outsourcing is the fastest growing area, with sales revenues there increasing by almost 18 percent. The Gartner Group also expects a growth of eight percent by 2007 for the whole outsourcing market.
Outsourcing and offshoring
However, classical outsourcing, that is the handover of company functions to an independent, external service provider, is just one facet of the future market, because the service provider’s resources are not always located in the same country as the customer. For some time, the area of offshoring has been merging with conventional outsourcing. “Outsourcing and offshoring form one market,” says Matzke. However, in the United States and the United Kingdom, a market dynamic has developed that is markedly different to that in other countries. “India is still the largest offshore service provider. Here, the English-speaking countries do not have to battle with language barriers. The Indians’ very good knowledge of English, for example, means that call center operations can easily be moved to India.”
Jürgen Aumüller, CEO of IT service provider Soft Design GmbH, who has already managed large offshore services projects, is also aware of the advantage the English-speaking world has in this area – at least in relation to the market in India. In Aumüller’s experience, the situation will be much more critical with regard to the new offshore providers in Eastern Europe. “Quite often, there is only one person in the service provider’s team that can speak the project language of English or German. In this case, misunderstandings are inevitable, as direct communication is not possible.” In addition to this game of Chinese whispers, other elements of offshore development have proven difficult for Aumüller. “In offshore projects, a particularly large amount of time must be invested in defining the requirements. After all, none of the developers sees the whole project, programming is done strictly in line with the requirements. In addition, there is a high employee turnover. As a result, it is almost impossible for the service provider to offer consulting services.”
The potential for saving depends on the project
However, the Soft Design CEO is skeptical about whether the users are always able to define their requirements with a sufficient degree of detail. As a result, in his opinion this type of outsourcing is particularly suited to consulting firms and software manufacturers: “Offshore providers as subcontractors offer the necessary flexibility here, with regard to both expertise and personnel.” He also believes that the greatest savings can be made in pure programming. For the companies using the services, however, this effect is often minimal, because programming work makes up only a very small part of extensive IT projects.
A study conducted by Soreon Research also confirms the risks involved in IT outsourcing. In this study, “Cashing Up: A Comparison of Offshore Outsourcing and Inhouse”, the market researchers recommend that companies build up their own quality assurance departments, among other things, so that the outsourcing measures can be evaluated objectively.
Jobs – a bone of contention
All the market experts agree that outsourcing and offshoring are businesses with a high potential. However, the advantages for the company in the form of lower project and operating costs are offset by the mistrust generated in the IT team, because outsourcing always means that fewer employees are needed in the company itself. The Gartner Group predicts that up to 25 percent of the traditional IT jobs in industrialized nations will move to the up-and-coming countries.
The Information Technology Association of America (ITAA) sees things quite differently. It found that around 35,000 jobs were lost annually in the United States between 2000 and 2003 as a result of offshore outsourcing – either the jobs were cut, or moved to other countries. However, as a result of this outsourcing, 90,000 IT jobs were indirectly created in the United States in 2003 alone, according to the current study “Global Sourcing of Software and IT Services”, because the companies invested the money saved by offshoring in the country, thus creating new jobs.
However, when it comes to offshoring, there are also companies in the United States that are now pulling their operations out of India, because of rising wage costs, among other things.