Is IT Outsourcing a Dying Concept?

Has the concept of IT outsourcing outlived its effectiveness? KPMG's Cliff Justice says the process that the term was invented to describe has evolved considerably and finding value in IT service providers is taking on new meaning.

According to a recent survey by outsourcing analyst firm HfS Research, 63 percent of IT leaders would like to drop the term "outsourcing" to describe the IT services provided to them by third-parties and 68 percent of IT service providers want to do away with the designation.

Outsourcing slumps

Some of that can be attributed to the negative connotations associated with the word "outsourcing," particularly on the heels of a presidential campaign that trotted out the practice as a job-destroying boogeyman.

But it could also be that the term has outlived its effectiveness. "Like many invented terms, the process it describes has evolved considerably from what it was initially," says Cliff Justice, partner in KPMG's Shared Services and Outsourcing Advisory.

In his report earlier this year, " The Death of Outsourcing," Justice argues that as the use of third-party IT service providers has evolved from a simple "lift-and-shift" back-office cost-cutting exercise to a complex ecosystem of smaller deals, higher expectations, and more business-centric services, the way customers and providers think and talk about outsourcing must advance as well.

The low-hanging fruit has been picked. Organizations will find it difficult to rely on their low-cost, low-margin service providers to be in a position to step up with the kind of investment needed to give them additional competitive advantages.

Instead of delineating between insourcing or outsourcing or offshoring, Justice writes that IT leaders should embrace the "extended global enterprise& not a specific model or set delivery structure, but rather a paradigm for delivering business services based on the concepts of end-to-end processes, internal and outsourced service providers, high value services and strong central governance."

CIO.com talked to Justice about the shift taking place in IT services, the inherent inertia on the part of both customers and providers to embrace new models, and the potential winners and losers in a world beyond outsourcing.

CIO.com: When did IT outsourcing really start to shift in terms of both structures and expectations and what have been the most significant changes?

Cliff Justice, KPMG: It really started to shift around 2006 to 2007. We are seeing a transition from outsourcing as a commodity that's very price-focused to a service that's much more value-oriented. Companies with the most mature arrangement--the ones I call "Extended Global Enterprises"--have shifted or are shifting to integrating the use of third-parties and managing that integration in a way that promotes their business goals. The result is more innovation, more new product ideas, and more new services.

CIO.com: Who's driving this transformation--customers or service providers?

Justice: Mainly the customers. The value that service providers can offer extends to helping a company compete more effectively in the marketplace for customers--by helping with product development or entering new markets, both of which help to drive customer growth.

CIO.com: You describe this as the "death of outsourcing." Why is outsourcing, in its present state, unsustainable?

Justice: Outsourcing became too reliant on labor arbitrage, which is a very short-sighted strategy. For example, wages in India have gone up from 10 to 14 percent yearly since 2009. Also, the offshore talent pool is smaller than it was five years ago, further limiting labor arbitrage as a strategy.

CIO.com: But isn't cost-cutting still an important factor in sourcing decisions, given continued pressure on IT to do more with less?

Justice: Cutting costs is very much a driver. However, companies are demanding more value from third-party services, such as the ability of the provider to partner and move business goals forward. That's a big change from the way it was five to ten years ago.

CIO.com: What kinds of outcomes are customers seeking from IT service providers? More importantly, are the providers capable of delivering them today?

Justice: Clients are looking for increased agility, reduced fixed costs, availability of working capital, better insights into trends they'll need to take advantage of, to name a few. Providers that are growing and excelling are aligning with their clients' industries and specializing in order to help their clients compete better. In so doing, they're becoming more valuable to their client organization.

CIO.com: Describe the new outsourcing customer.

Justice: The new customer is a blend of the CIO and the business. The CIO takes on more of the governance aspects of the provider relationship and manages the overall technology impacts across the enterprise that includes a blend of sourcing models to deliver increased value. The business side continues to mature as a technology buyer, not only to provide business requirements but also to have a strong and educated opinion on the technology that they want to use to further the goals of the business.

CIO.com: What does that mean for the service providers? Who will be the winners and losers?

Change is constant, but always difficult and often mismanaged. Ensure you have aligned the business goals with the service delivery model.

Justice: Service providers will need to develop or enhance strategies and skills that position them as "business first" solution providers and not solely as technology or transaction companies. Those that can provide business- and industry-specific solutions that create innovation, reduce costs, reduce risk and provide competitive advantage for their clients across the entire back office will be the winners.

CIO.com: Will the vendor sales teams have to make adjustments?

Justice: They will need to become more focused on business outcome than on price alone. Key measures of success need to focus on the value-added capabilities of the organization to bring innovation and improve quality, flexibility and speed to market while integrating with all areas of the business and not just certain parts of it.

CIO.com: This next generation sourcing model has clear benefits, but change is difficult. How can customers and service providers overcome inertia?

Justice: Leadership needs to come from the top. Successful organizations set clear objectives in their sourcing strategies from their leadership. This is not a "once and done" model. It requires a consistent, well-thought-out and ongoing communication of this strategy and the change that the organization is going through. The service providers that will be successful are those that partner with the organization to bring the change management and communication mindset that identifies them as part of the team and supporting the change.

CIO.com: You say that such changes may be hardest for those who have been most successful at outsourcing for cost savings in the past.

Justice: The low-hanging fruit has been picked and reinvestment may be needed to get to the next level of value creation. Pressure on cost reduction continues in organizations and companies that looked solely at labor arbitrage opportunities with little concern or strategy for innovation. These organizations will find it difficult to rely on their low-cost, low-margin service providers to be in a position to step up with the kind of investment needed to give them additional competitive advantages.

Those companies that adopt a holistic approach to sourcing will need to balance the needs of the business for innovation and quality with the need to maintain the low cost structure achieved through aggressive outsourcing and offshoring in past agreements.

CIO.com: What advice do you offer IT leaders to make this shift?

Justice: Take a long-term view of the road ahead. This will be a gradual shift as the organization adapts. Change is constant, but always difficult and often mismanaged. Ensure you have aligned the business goals with the service delivery model. Plan for change. Communicate often. And reinforce the alignment of IT leadership with the business leaders.

Stephanie Overby is regular contributor to CIO.com's IT Outsourcing section.

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Read more about outsourcing in CIO's Outsourcing Drilldown.

This story, "Is IT Outsourcing a Dying Concept?" was originally published by CIO .

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